SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
 
 FORM
10-K
 
 xANNUAL REPORT PURSUANT TO
      SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For the fiscal year ended December 31,
      2008
 or
 oTRANSITION REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
      For the transition period from
      ____to____.
 
 Commission
file number: 000-14801
 
 MIKROS SYSTEMS
CORPORATION
 (Exact
Name of Registrant as Specified in Its Charter)
 
 Delaware
              14-1598200(State
      or Other Jurisdiction of
              (I.R.S.
      EmployerIncorporation
      or Organization)
              Identification
      No.)
 
 707 Alexander Road, Suite
208, Princeton, New Jersey,08540
 (Address
of Principal Executive Offices) (Zip Code)
 
 609-987-1513
 Registrant’s
Telephone Number, including area code:
  Securities Registered
Pursuant to Section 12(b) of the Exchange Act:
 None
 
 Securities Registered
Pursuant to Section 12(g) of the Exchange Act:
 Common
Stock, $.01 par value
 
 Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  Yes [  ] No [X]
  Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Exchange Act.  Yes [  ] No
[X]
  Indicate
by check mark whether the registrant (1) filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act 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
[X] No [   ]
 
 Indicate
by check mark if disclosure of delinquent filers in response to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [X]
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definitions of "large accelerated filer”, “accelerated filer" and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
  Large Accelerated
      Filer
                [  ]
                Accelerated
      Filer
                [  ]Non-accelerated
      Filer
                [  ]
                Smaller Reporting
      Company
                [X](Do not check if a
      smaller reporting company.)
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).Yes [  ] No [X]
 
 The
aggregate market value of the voting and non-voting common equity held by non
affiliates of the registrant as of June 30, 2008, the last business day of the
registrant’s most recently completed second fiscal quarter,  based on
the last sales price of the issuer’s common stock as reported on the OTCBB was
$3,541,640.  Shares of common stock held by each current executive
officer and director and by each person who is known by the registrant to own 5%
or more of the outstanding common stock have been excluded from this computation
in that such persons may be deemed to be affiliates of the
registrant.  This determination of affiliate status is not a
conclusive determination for other purposes.
 
 As of
March 24, 2009, 31,766,753 shares of the registrant's common stock were
outstanding.
  1
  TABLE
OF CONTENTS
  PagePART
      IItem
      1.
                Business
                3Item
      1A.
                Risk
      Factors
                9Item
      2.
                Properties.
                12Item
      3.
                Legal
      Proceedings
                13Item
      4.
                Submission
      of Matters to a Vote of Security Holders
                13PART
      IIItem
      5.
                Market
      For Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                13Item
      7.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operation
                14Item
      8.
                Financial
      Statements and Supplementary Data
                20Item
      9.
                Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure
                20Item
      9A(T)
                Controls
      and Procedures
                20Item
      9B.
                Other
      Information
                21PART
      IIIItem
      10.
                Directors,
      Executive Officers and Corporate Governance
                21Item
      11.
                Executive
      Compensation
                23Item
      12.
                Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                26Item
      13.
                Certain
      Relationships and Related Transactions, and Director
      Independence
                32Item
      14.
                Principal
      Accountant Fees and Services
                32Item
      15.
                Exhibits
      and Financial Statement Schedules
                33Financial
      Statements
                35
 2
 PART
I
 
 DISCLOSURE
REGARDING FORWARD-LOOKING STATEMENTS
 
 This
report contains “forward-looking statements” within the meaning of Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended.  All statements other than
statements of historical facts included or incorporated by reference in this
report, including, without limitation, statements regarding our future financial
position, business strategy, budgets, projected revenues, projected costs and
plans and objective of management for future operations, are forward-looking
statements.  In addition, forward-looking statements generally can be
identified by the use of forward-looking terminology such as “may,” “will,”
“expects,” “intends,” “plans,” “projects,” “estimates,” “anticipates,” or
“believes” or the negative thereof or any variation there on or similar
terminology or expressions.
 
 These
forward-looking statements are subject to risks and uncertainties that could
cause actual results to differ materially from results proposed in such
statements.  Although we believe that the expectations reflected in
such forward-looking statements are reasonable, we can give no assurance that
such expectations will prove to have been correct.  Important factors
that could cause actual results to differ materially from our expectations
include, but are not limited to:  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 Innovation Research (SBIR) grants,
competitive pricing pressures, market acceptance of our products under
development, delays in the development of products, and statements of assumption
underlying any of the foregoing, as well as other factors set forth under “Item
1A. Risk Factors” beginning on page 6of this report and “Item
7 - Management’s Discussions and Analysis of Financial Condition and Results of
Operation” below.
 
 All
subsequent written and oral forward-looking statements attributable to us, or
persons acting on our behalf, are expressly qualified in their entirety by the
foregoing.   Except as required by law, we assume no duty to
update or revise our forward-looking statements based on changes in internal
estimates, expectations, or otherwise.
 
 ITEM
1.  BUSINESS.
 
 Mikros
Systems Corporation (“Mikros”, “the Company”, “we” or “us”) is an advanced
technology company specializing in the research and development of electronic
systems technology primarily for military applications.  Classified by
the U.S. Department of Defense (DoD) as a small business, our capabilities
include technology management, electronic systems engineering and integration,
radar systems engineering, combat/command, control, communications, computers
and intelligence (C4I) systems engineering, and communications
engineering.
 
 History of the
Company
 
 Founded
in 1978 in Albany, New York, Mikros was formed to leverage the microprocessor
advancements coming out of the nearby General Electric Research and Development
Center into state-of-the-art digital signal processing applications for the
defense industry.  We specialized in developing technology and
products advancing the state of military RF (radio frequency or wireless) and
underwater data communications.  Through several U.S.  SBIR
awards in the early 1990s, we developed and fielded the AN/USQ-120
Multi-Frequency Link-11 Data Terminal Set still in use today by the U.S.
Navy.
  In the
mid 1990s, we began shifting our core business area away from military
communication applications to the rapidly expanding commercial wireless
communications arena.  Our advanced Digital Signal Processing (DSP)
technology base and core competencies enabled us to develop unique, proprietary
technology, high-speed data broadcasting techniques utilizing the commercial AM
and FM radio spectrum.  In 1998, we sold our military communications
business to an unrelated third party.
  3
  Due to
expanding cellular and satellite communications technologies, market demand for
commercial wireless data broadcasting (one-way communication) applications never
fully materialized. Upon expiration of our non-compete restrictions imposed by
the 1998 sale of our military communications business, we shifted our focus back
to research and development for military electronic systems.  Our past
successes in the U.S. DoD SBIR program (11 awards from 1988 through 1996) gave
us confidence we could be successful going forward. In 2002, we began developing
SBIR initiated technology products within our areas of expertise, and remain
committed to this strategic approach today.
  Adaptive Diagnostic
Electronic Portable Testset (ADEPT®)
  In May
2002, the U.S. Navy’s Dahlgren Division, Naval Surface Warfare Center (“NSWCDD”)
awarded us a $100,000 Phase I SBIR contract to investigate the feasibility of a
Multi-Function Distributed Analysis Tool, or MFDAT.  As envisioned,
the MFDAT is a semi-automated, intelligent test tool designed to support U.S.
Navy technical personnel in the maintenance, alignment and diagnosis of complex
electronic systems.  The overall objectives of the MFDAT program
were:
  ·
              To
      achieve higher readiness through reduced maintenance downtime and better
      system assurance;
 ·
              To
      increase system reliability by supporting predictive failure analysis and
      proactive remediation; and
 ·
              To
      promote more effective use of technicians through increased automation,
      distance support and interactive
training.
 
 The
completed Phase I program produced an operational, proof-of-concept, software
demonstration/simulation model of the MFDAT system.
  In August
2003, we were awarded a $750,000 Phase II SBIR contract from NSWCDD to continue
our development of the MFDAT system.  The Phase II program produced a
prototype system capable of performing alignment and maintenance procedures on
the Aegis AN/SPY-1A radar system.  This MFDAT prototype system proved
the viability of incorporating the functionality of multiple electronic test
equipment into a single, programmable system.
  The MFDAT
technology enables common testing processes, training, and equipment for
electronic system support thereby providing a viable path toward meeting the
U.S. Navy’s readiness goals while reducing the dependency on manpower, manpower
training, and discrete test equipment.  The success of our MFDAT Phase
II program prompted the U.S. Navy to award an additional $250,000 enhancement to
the Phase II contract to accelerate the commercialization of this technology
into a product suitable for naval shipboard use.  The output of this
Phase II SBIR program was a fully-functional MFDAT prototype.
  4
  In
September 2004, we received an SBIR Phase III contract from NSWCDD valued at
approximately $2,400,000 to commercialize our MFDAT technology into a
fully-integrated, man-portable test tool qualified for U.S. Navy fleet
use.  This contract secures our SBIR data rights in the MFDAT
technology for a period of five years beyond the last delivery under this
contract, or any subsequent SBIR Phase III contracts. We changed the name of the
product to Adaptive Diagnostic Electronic Portable Testset (ADEPT®) (ADEPT
is a registered trademark of Mikros Systems Corporation). The current ADEPT
system is a computer-aided alignment and maintenance tool for the AN/SPY-1 radar
system, which is the primary air, and surface radar for the Aegis Combat System
installed on the USS Ticonderoga (CG-47) and USS Arleigh Burke (DDG-51) class
guided missile warships.  Key anticipated benefits of ADEPT
include:
  ·
              Significant
      reduction in system calibration, alignment, maintenance, and repair
      times;
 ·
              Improved
      system readiness, availability, and
performance;
 ·
              More
      effective use of technical manpower through increased automation, distance
      support, and interactive training;
 ·
              Distance
      support capable enabling “expert” remote (shore-based) system support and
      fleet-wide system analysis;
 ·
              Reduction
      in the amount of electronic test equipment required for organizational
      level support; and
 ·
              Modular
      and programmable to overcome current test equipment obsolescence issues
      and to support capability enhancements in future
  systems.
 
 The first
ADEPT Low Rate Initial Production (LRIP) units were manufactured in 2005 and
have undergone extensive shipboard and land-based testing.  On March
2, 2006, we received a modification to the SBIR Phase III contract for
additional funding in the amount of $2,950,000 from The Department of the Navy
for the continuation of the development and production of our ADEPT maintenance
tool for U.S. Navy surface combatants.  This modification included
technology upgrades that have expanded the application of ADEPT to include all
Aegis ship variants for cruisers and destroyers.  This market is
comprised of over 80 ships plus shore-based facilities.  Future
systems upgrades will expand the potential market to include foreign navies and
other U.S. Navy ships for a potential market of more than 200
ships.
  On April
30, 2007, we were awarded a $2,400,000 contract from the Naval Surface Weapons
Center, Port Hueneme Division (“NSWCPHD”) for the continuing development of
ADEPT.  NSWCPHD is the U.S. Navy’s In-Service Engineering Agency
(ISEA) for the AN/SPY-1 Radar System. This contract provides for the continuing
development of advanced capabilities for ADEPT, completion of the ADEPT
Integrated Logistics Support Plan required for fleet fielding, delivery of 10
ADEPT(V)2 LRIP units, which are half the size and weight of the original
ADEPT(V)1, while maintaining the same functionality.   The
contract follows successful testing and evaluation of ADEPT on one AEGIS cruiser
along with testing at the Navy’s AN/SPY-1 Cruiser Modernization Test Facility in
Moorestown, NJ.  It is expected that the ADEPT equipment will
initially be installed on AEGIS cruisers undergoing modernization with
introduction into the destroyers to follow.  The entire U.S. Navy
AEGIS fleet consists of 22 cruisers and 62 destroyers.
 
 On
September 29, 2008, we were awarded an $800,000 modification to our contract
with NSWCPHD for an additional 8 ADEPT LRIP units and additional logistics
development work. The logistics effort includes development of fielding support
and calibration plans required for widespread use of ADEPT aboard U.S. Navy
ships.  We expect to deliver the 8 LRIP units to the Navy in the third
quarter of  2009.  An additional 4 units may  be
added to this order for a total of 12 deliveries in this time
frame.
 
 The goal
for this program is to obtain a multi-year Indefinite-Delivery,
Indefinite-Quantity (IDIQ) contract for production, engineering, and logistics
support.  We anticipate this contract award and additional orders for
ADEPT equipment in the third quarter of 2009.  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 this contract and future ADEPT orders.
  5
 
 Key
partners in the ADEPT program include DRS Technologies of Largo, FL and
Johnstown, Pennsylvania; Lockheed Martin Corporation of Moorestown, New Jersey;
Raytheon Corporation of Sudbury, MA; and, In-Phase Technologies of Clarksburg,
New Jersey.  DRS Technologies assisted in the development of the ADEPT
ruggedized enclosure and currently performs enclosure manufacturing, test, and
qualification.  As the designer of the SPY-1 radar and lead systems
integrator for the Aegis system, Raytheon and Lockheed Martin Corporation
provides subject matter expertise. In-Phase Technologies provided assistance in
the development of ADEPT virtual instrumentation.
  Wireless Local Area Network
Systems
  We began
work on another independent SBIR subject area in June 2004.  The
Office of Naval Research awarded us a $100,000 SBIR Phase I contract to analyze
the potential for interference between emerging Wireless Local Area Network
systems (WLANs) and DoD radar systems, and to evaluate and quantify the
potential improvements which may be afforded by selected mitigation
techniques.  This Radar Wireless Spectral Efficiency (RWSE) SBIR Phase
I program was completed in January 2005 and concluded that the potential exists
for mutual interference between WLANs and DoD radars, particularly during
land-based, littoral and harbor navigation operation of DoD
radars.  We recommended that further study of the identified mutual
interference mechanisms was warranted, including empirical testing to
characterize the effects of the interference and the potential mitigation
techniques identified during the Phase I program.
  In May,
2007, we were awarded SBIR Phase II funding through Space and Naval Warfare
Systems Command (SPAWAR), located in San Diego, California.  This $750,000
effort is a spin off of work performed under the SBIR topic entitled Radar
Wireless Spectral Efficiency (RWSE).  This SBIR Phase II effort, entitled
‘Kill Chain Vulnerability Analysis Tool’, focuses on the interaction between
tactical data links and interferers such as hostile jammers.  We are
working closely with engineers from the Naval Air Warfare Center Weapons
Division (NAWCWD), located in China Lake, California, on this project. 
NAWCWD, a division of Naval Air Systems Command (NAVAIR), is responsible for
‘Arming the Fleet’. The technical objective of this effort is to develop
simulation models that can be used to predict the performance of data links in a
jamming environment.
  Radar Wireless Spectral
Efficiency
  On May 1,
2006, we were awarded an SBIR Phase II contract from SPAWAR as a follow-on to
our SBIR Phase I work performed under the SBIR topic entitled
RWSE.  The total award is valued at approximately $750,000 divided
into a $600,000 base program and a $150,000 option program.  This SBIR
Phase II effort focused on the real world implications of incorporating wireless
networking into the aircraft carrier (CVN platform) environment.  The
overall technical objective is to facilitate the introduction of commercial
wireless communication systems, e.g. Wi-Fi, onto U.S. Navy ships
through:  (1) the identification and testing of potential own-ship
electromagnetic interference (EMI) issues; (2) the development and testing of
viable mitigation technologies to overcome adverse EMI effects; and (3) the
development of a CVN Wi-Fi network planning tool to support networking within a
highly reconfigurable shipboard environment.  This contract was
initially for the CVN platform, but is expected to be eventually applicable to
other U.S. Navy ships.
  As part
of this RWSE SBIR Phase II program, our engineers have performed Wi-Fi
propagation surveys aboard the aircraft carrier USS GEORGE WASHINGTON (CVN-73)
and the amphibious assault ship USS BATAAN (LHD-5).  The empirical
results from these surveys were used to refine the Wi-Fi signal propagation
algorithms embedded in the Wireless Network Planning Tool
prototype.  In March 2007, our engineers sailed aboard the U.S. Navy
amphibious assault ship USS KEARSARGE (LHD-3) during its underway exercise in
the Atlantic Ocean near Norfolk, Virginia.  This afforded us the
opportunity to measure the shipboard radio frequency environment during actual
at-sea operating conditions.  This information is critical to
analyzing potential interference to and from commercial wireless networks and to
validate the interference aspect of the Interference-Aware Wireless Network
Planning Tool currently under development.
  6
 
 In May,
2007, we were awarded additional funding on SBIR Topic “A Study of Commercial
Wireless LAN Interference Issues Aboard U.S. Navy Carriers” (CVNs).  The
contract is a follow-on to the SBIR Phase I work we performed under RWSE. The
additional funding of $150,000 was awarded to us from SPAWAR, bringing the total
amount of the SBIR Phase II contract to $750,000.  During the contract
option period, together with our team partner Mobilisa Inc., we plan to continue
development of AIRchitect - EMC, a software package which allows the Navy to
plan and optimize deployment of shipboard WiFi networks.  AIRchitect - EMC
automatically places shipboard Access Points to optimize coverage based on 
user-specified wireless requirements.  It also analyzes potential
interference between network equipment and onboard RF systems such as radars,
and where possible, mitigates interference using smart placement and channel
selection algorithms.  AIRchitect - EMC will be used by the Navy to plan
network deployments on aircraft carriers (CVNs) and other
platforms.
  Additional
Contracts
 
 In
May 2008, we were awarded two new contracts for follow-on work based on the
AIRchitect-EMC wireless network design tool developed under the RWSE Phase II
contract.  These are both pilot programs where the Navy is using
AIRchitect-EMC to design shipboard wireless networks for LHD amphibious ships
and CVN aircraft carriers.  If these programs are successful, we
believe there are significant related future opportunities to apply
AIRchitect-EMC more broadly as the Navy continues to expand wireless network
deployments.
 
 The first
program is a subcontract to the Navy’s Classified Wireless Networks for Embedded
Forces program, which is a pilot program run by PMW160 and funded by the Office
of Naval Research Rapid Technology Transition program.  AIRchitect-EMC
will be used to help design a shipboard network for use by USMC Marine
Expeditionary Forces, and networks will be installed on two LHD
ships.  This program is funded initially at $50,000 in 2008, with
additional funding expected in 2009
 
 The
second program is funded directly by the Navy’s PMW750 CVN program office, and
covers network design studies for the new aircraft carrier USS Gerald R.
Ford.  This program is valued at $100,000 in 2008, and if successful
may also result in additional funding in 2009.
 
 In
February 2009 we were awarded a $68,000 production support contract on the
Navy’s Next Generation Command and Control Processor (NGC2P) program by Northrop
Grumman Corporation. The NGC2P system is a tactical data link (TDL)
communications processor which provides warfighters with critical real-time
information during combat operations. We anticipate future work with Northrop
Grumman in areas associated with our expertise in electronic systems development
and wireless technologies.
 
 In
February 2009 we were awarded a $9,991 subcontract from Gnostech, Inc of
Warminster, PA for Engineering Services in support of Gnostech’s program ‘GPS
Scenario Development and Test Support for both Electronic Protection and
Electronic Attack Threat Environment’.
 
 Corporate Growth &
Strategy
  Our
strategy for continued growth is three-fold.  First, we expect to
continue expanding our technology base, backlog, and revenue by continuing our
active participation in the DoD SBIR program, bidding on projects that fall
within our areas of expertise – electronic systems engineering and integration,
radar systems engineering, combat/C4I (Command, Control, Communications,
Computers & Intelligence) systems engineering, and communications
engineering.  We believe that we can utilize the intellectual property
developed under our various SBIR awards to develop proprietary products, such as
the ADEPT described above, with broad appeal in both the government and
commercial marketplace. This state-of-the-art test equipment can be used by many
commercial and governmental customers such as the FAA, radio and TV 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.
  7
  Third, we
believe that through our marketing of products such as ADEPT® we will develop
key relationships with prime defense system contractors.  Our strategy
is to develop these relationships into longer-term, key subcontractor roles on
future major defense programs awarded to these prime contractors.
 
 Competition
 
 Competition
in the SBIR arena is intense, and we compete against numerous small businesses
for SBIR awards.  In our general business area of electronic defense
systems and products, we also compete against many larger companies which have
greater financial and human resources than we do.We believe that
the primary competitive factors in obtaining SBIR contracts are technical
expertise, prior relevant experience, and cost.  Our history of
completing projects in a timely and efficient manner and the experience of our
management and technical personnel positions us well to compete for future SBIR
grants.
 
 Intellectual
Property
 
 We have
two patents covering digital signal processing technology and our base scheme of
implementing Link-11.  We have also developed and continue to develop
intellectual property (technology and data) under our SBIR contracts. Our
request for a trademark for the product name “ADEPT” has been approved by the
U.S. Patent and Trademark Office, and ADEPT® is now a registered
trademark.
 
 Under
SBIR data rights, we are protected from unauthorized use of SBIR-developed
technology and data for a period of five years after acceptance of all items to
be delivered under a particular SBIR contract or any follow-on
contract.
 
 Customer Concentration;
Dependence on Federal Government
 
 Substantially
all of our revenue is derived from SBIR contracts for the Federal
Government.  Although our operations are not subject to any particular
government approval or regulations, we are dependent upon funding being made
available to the Department of Defense in amounts sufficient to cover the SBIR
grants that we compete for.
 
 Research and
Development
 
 We are a
specialized research and development company focused on the development of
electronic systems technology primarily for military
applications.  All of our research and development costs in 2008 and
2007 were for the benefit of our customers, agencies of the Federal
Government.  The customer-sponsored research and development projects
are performed under contracts and are accounted for as contract costs as the
work is performed.  In future periods, we may engage in
company-sponsored research and development projects which would be expensed as
incurred.
 
 Employees
 
 As of
December 31, 2008, we had ten full-time employees working at our Fort
Washington, Pennsylvania Research & Development Center.  None of
the employees belong to a labor union.  We believe relations with our
employees are satisfactory.   We also use the services of
subcontractors and/or consultants as necessary to aid in software and hardware
development and for the manufacture of products.
  8
 
 ITEM
1A.  RISK FACTORS.
 
 An
investment in our common stock involves a high degree of risk.  You
should carefully consider the following risk factors in addition to other
information in this Annual Report on Form 10-K before purchasing our common
stock. The risks and uncertainties described below are those that we currently
deem to be material and that we believe are specific to our company and our
industry.  In addition to these risks, our business may be subject to
risks currently unknown to us.  If any of these or other risks
actually occurs, our business may be adversely affected, the trading price of
our common stock may decline and you may lose all or part of your
investment.
 
 RISKS
ASSOCIATED WITH OUR BUSINESS AND OR INDUSTRY
 
 We have a history of operating
losses.  Although we had net income of $55,099 for the year
ended December 31, 2008 and a working capital surplus of $554,352, we still had
an accumulated deficit of $11,312, 795 at December 31, 2008.
 
 A decline in or a redirection of the
U.S. defense budget could result in a material decrease in our sales, earnings
and cash flows.Our government contracts are primarily
dependent upon the U.S. defense budget. We, as well as other defense
contractors, have benefited from increased overall DoD spending over recent
years.  However, future DoD budgets could be negatively affected by
several factors, including events we cannot foresee, U.S. Government budget
deficits, current or future economic conditions, new administration priorities,
U.S. national security strategies, a change in spending priorities, the cost of
sustaining U.S. military and related security operations in Iraq and Afghanistan
and other locales around the world where U.S. military support may be pivotal,
and other related exigencies and contingencies. While we are unable to predict
the impact and outcome of these uncertainties, the effect of changes in these
DoD imperatives could cause the DoD budget to remain unchanged or to decline (or
even to increase). A decline in or redirection of U.S. military expenditures in
the future could result in a decrease to our earnings and cash
flows.
 
 We rely predominantly on U.S.
Government entities, and the loss of our contracts could have a material adverse
effect on our results of operations and cash flows.Our
earnings are predominantly derived from contracts with agencies of the U.S.
Government. The loss of any of our contracts with the U.S. Government could have
a material adverse effect on our results of operations and cash
flows.
 
 In
addition, future financial results may be adversely affected by:
 
 ·
              curtailment
      of the U.S. Government’s use of technology or other services and products
      providers, including curtailment due to government budget reductions and
      related fiscal matters;
 ·
              developments
      in Iraq, Afghanistan or other geopolitical developments that affect demand
      for our products and services;
 ·
              our
      ability to hire and retain personnel to meet increasing demand for our
      services; and
 ·
              technological
      developments that impact purchasing decisions or our competitive
      position.
 
 We may experience variability in our
quarterly operating results.  Our revenue, gross profit,
operating income and net income may vary from quarter to quarter due to a number
of factors. Many factors, some of which are not within our control, may
contribute to fluctuations in operating results. These factors include the
following:
 
 ·
              market
      acceptance of our new products;
 ·
              budgetary
      constraints of the federal
government;
 ·
              new
      product and service introductions by our competitors or
  us;
 ·
              our
      employment patterns;
 ·
              market
      factors affecting the availability or costs of qualified technical
      personnel;
 ·
              timing
      and customer acceptance of our new product and service
      offerings;
 ·
              length
      of sales cycle; and
 ·
              industry
      and general economic conditions.
 
 9
  Our success depends on the services
of our senior management and our ability to hire and retain additional skilled
personnel.  The future
success of our company depends on the personal efforts and abilities of the
members of our senior management team to provide strategic direction, develop
business, manage operations and maintain a cohesive and stable environment.
Specifically, we are dependent upon Thomas J. Meaney, President and Chief
Executive Officer, Walter T. Bristow, Vice President of Engineering, Marc Dalby,
Vice President of Business Development and Program Management, and Henry
Silcock, Chief Technology Officer.  We do not have employment
agreements with any key personnel. Furthermore, our performance also depends on
our ability to attract and retain management and qualified professional and
technical operating staff. Competition for these skilled personnel is intense.
The loss of services of any key executive, or inability to continue to attract
and retain qualified technical staff, could have a material adverse effect on
our business, results of operations and financial condition. We do not maintain
any key employee insurance on any of our executives.
 
 The demand for our products is
subject to rapid technological change.  The demand for our
products and planned products is characterized by rapid changes in technology,
including the potential introduction of new types of wireless communications and
digital signal processor technologies which could have a material adverse impact
on our business.  Our future success will depend in part on our
ability to continually enhance our current technology and to develop or acquire
new ideas that address the needs of the defense industry and other potential
users.  There can be no assurance that we will be successful in
developing new products or procedures that respond to technological changes.
There can be no assurance that research and development by competitors will not
render our technology obsolete or uncompetitive.  In addition, in a
technology-based industry, there can be no assurance that a claim of patent or
other infringement will not be made against us.  While we are not
aware of any such claims, no infringement studies have been conducted on our
behalf.
 
 Our industry is highly
competitive.High technology applications such as those being
developed by us often require large investments of both money and
talent.  Many large entities with greater financial, technical and
human resources than us are currently investing heavily in products and services
that compete directly with our services and underlying products. There is no
assurance that our offerings can be successfully marketed against such
competition.  In addition, being first in the market with new high
technology is a critical factor in a company’s success in the market. There is
no assurance that we will be able to introduce new offerings to the market
before any of our competitors.  As the markets in which we compete
mature and new and existing companies compete for customers, price competition
is likely to intensify, and such price competition could adversely affect our
results of operations.
 
 Our government contracts contain
unfavorable termination provisions and are subject to audit and modification.If a termination right is exercised by the government, it could have a
material adverse effect on our business, financial condition and results of
operations. Companies engaged primarily in supplying defense-related equipment
and services to U.S. Government agencies are subject to certain business risks
peculiar to the defense industry. These risks include the ability of the U.S.
Government to unilaterally:
 
 ·
              suspend
      us from receiving new contracts;
 ·
              terminate
      existing contracts;
 ·
              reduce
      the value of existing contracts;
and
 ·
              audit
      our contract-related costs and fees, including allocated indirect
      costs.
 
 All of
our U.S. Government contracts can be terminated by the U.S. Government either
for its convenience or if we default by failing to perform under the contract.
Termination for convenience provisions provide only for our recovery of costs
incurred or committed settlement expenses and profit on the work completed prior
to termination. Termination for default provisions provide for the contractor to
be liable for excess costs incurred by the U.S. Government in procuring
undelivered items from another source.
 
 We rely on third-party contractors
for certain engineering services that may be difficult to
replace.  We currently provide a portion of our engineering
services through third-party contractors such as DRS Technologies.,
Inc.  These services may not continue to be available on commercially
reasonable terms, if at all.  Services that are not immediately
replaceable would need to be internally developed, which could strain existing
engineering personnel and require us to spend substantial time and resources to
retain additional personnel or third-party contractors.  The loss or
inability to maintain any of these engineering service providers could result in
delays in the development of our products and services until equivalent
services, if available, are identified, developed, and integrated, which could
harm our business.
  10
 
 We have limited operating history in
providing commercial wireless applications. Historically, we developed
and sold technology and products for military applications, primarily to the
U.S. Navy.  We may in the future develop commercial wireless products
and applications that would perform different functions than our historic
products, and would be targeted at an entirely different customer
base.  Because we have not previously operated as a provider of
commercial wireless products, we have no basis to evaluate our ability to
develop, market and sell such products.  Our ability to commercialize
any products or services and generate operating profits and positive operating
cash flow will depend principally upon our ability to:
 
 ·
              develop
      and manufacture commercially attractive
  products;
 ·
              attract
      and retain an adequate number of
customers;
 ·
              enter
      new markets and compete successfully in
them;
 ·
              manage
      operating expenses;
 ·
              raise
      any necessary capital; and
 ·
              attract
      and retain qualified personnel.
 
 RISKS
RELATED TO OUR COMMON STOCK
 
 We may issue additional shares of our
capital stock that could dilute the value of your shares.  Our
outstanding securities include shares of convertible preferred stock and options
to purchase common stock.  During the respective terms of the options,
and while the preferred stock is outstanding, the holders thereof are given an
opportunity to profit from a rise in the market price of our common stock,
causing a dilution of the interests of existing stockholders.  Thus,
the terms on which we may obtain additional financing during that period may be
adversely affected.  The holders of preferred stock and options may
exercise their respective rights to acquire our common stock at a time when we
could be seeking to raise additional capital through sales of securities on
terms more favorable than those being offered by us to new
investors.  In the event that such holders exercise their rights to
acquire shares of our common stock at such time, the net tangible book value per
share of our common stock will be subject to dilution.
 
 Future sales of our securities by
existing stockholders could adversely affect the market price of our common
stock.  Future sales of shares by existing stockholders under
Rule 144 of the Securities Act of 1933 or through the exercise of outstanding
options or otherwise could have a negative impact on the market price of our
common stock.  We are unable to estimate the number of shares that may
be sold under Rule 144 because such sales depend on the market price for our
common stock, the personal circumstances of the sellers and a variety of other
factors.  Any sale of substantial amounts of our common stock in the
open market may adversely affect the market price of our common stock and may
adversely affect our ability to obtain future financing in the capital
markets.
 
 Penny Stock
Rules.Our common stock currently trades on the OTC Bulletin
Board. Since our common stock continues to trade below $5.00 per share, our
common stock is considered a “penny stock” and is subject to SEC rules and
regulations which impose limitations upon the manner in which our shares can be
publicly traded. These regulations require the delivery, prior to any
transaction involving a penny stock, of a disclosure schedule explaining the
penny stock market and the associated risks.  Under these regulations,
certain brokers who recommend such securities to persons other than established
customers or certain accredited investors must make a special written
suitability determination regarding such a purchaser and receive such
purchaser’s written agreement to a transaction prior to sale.  These
regulations may have the effect of limiting the trading activity of our common
stock and reducing the liquidity of an investment in our common
stock.
 
 We have never paid dividends on our
common stock and we do not anticipate paying dividends in the foreseeable
future.We have never paid cash dividends on our common
stock.  Any payment of cash dividends in the future will depend upon
our earnings (if any), financial condition and capital requirements. We do not
anticipate paying dividends in the foreseeable future. In addition, we have
executed certain loan agreements, which prohibit the payment of a dividend on
our common stock as long as such agreements are in
place.  Accordingly, any potential investor who anticipates the need
for current dividends from its investment should not purchase any of our
securities.
  11
 
 Our common stock is thinly traded and
the price of our common stock may experience price
volatility.  Our common stock currently is traded
over-the-counter on the OTC Bulletin Board.  There can be no assurance
that an active market for our shares will develop or, if developed, will be
sustained.  Absent a public trading market, an investor may be unable
to liquidate its investment.  We believe that factors such as the
announcements of the availability of new services and new contracts by us or our
competitors, quarterly fluctuations in our financial results and general
conditions in the communications industry could cause the price of our common
stock to fluctuate substantially. If stockholders seek to sell their shares in a
thinly traded stock, it may be difficult to obtain the price
desired.  In addition, stock markets have experienced extreme price
volatility in recent years.  This volatility has had a substantial
effect on the market prices of securities issued by many companies for reasons
unrelated to the operating performance of the specific companies.
  Our share ownership is highly
concentrated.  Our directors, officers and principal
stockholders, and certain of their affiliates, beneficially own approximately
31.4% of our common stock and will continue to have significant influence over
the outcome of all matters submitted to the stockholders for approval, including
the election of our directors.  In addition, such influence by
management could have the effect of discouraging others from attempting to take
control of us, thereby increasing the likelihood that the market price of our
common stock will not reflect a premium for control.
 
 We have adopted certain anti-takeover
provisions.  We are authorized to issue 4,040,000 shares of
preferred stock, which may be issued by our board of directors on such terms,
and with such rights, preferences and designations as the board may determine.
Issuance of such preferred stock, depending upon the rights, preferences and
designations thereof, may have the effect of delaying, deterring or preventing a
change in control of our company.  The existing 2,052,433 shares of
issued and outstanding preferred stock have certain rights and preferences,
including dividend and liquidation preferences, which also may have the effect
of delaying, deterring or preventing a change in control of us.  In
addition, certain “anti-takeover” provisions of the Delaware General Corporation
Law (the “DGCL”), among other things, restrict the ability of stockholders to
effect a merger or business combination or obtain control of the Company, and
may be considered disadvantageous by a stockholder.
 
 Corporate governance requirements are
likely to increase our costs and make it more difficult to attract and retain
qualified directors.   We are subject to the
Sarbanes-Oxley Act of 2002, as well as rules adopted pursuant to that
legislation by the SEC.  We expect that these and other new laws,
rules and regulations will continue to increase our legal and financial
compliance costs and place a significant burden on management.  We
also expect that new regulatory requirements will make it more difficult and
more expensive for us to obtain director and officer liability
insurance.  We may be required to accept reduced coverage or incur
significantly higher premium costs to obtain coverage.  These new
requirements are also likely to make it more difficult for us to attract and
retain qualified individuals to serve as members of our board of directors or
committees of the board, particularly the audit committee.   In
addition, starting with our fiscal year ended December 31, 2007, we became
subject to the requirements of Section 404 of the Sarbanes-Oxley Act which
requires us to make annual assessments of our internal control over financial
reporting and starting with our fiscal year ending December 31, 2009 file an
attestation of this assessment by our independent registered public accountants,
unless extended by the SEC as currently proposed.  To date, we have
taken limited actions with respect to compliance with the auditor attestation
requirement under Section 404.  We may need to hire additional
personnel and/or engage outside consulting firms to assist in our efforts to
comply with Section 404.  Any failure to improve our internal
accounting controls or other problems with our control systems could result in
delays or inaccuracies in reporting financial information or non-compliance with
SEC reporting and other regulatory requirements, any of which could adversely
affect our business and stock price.
 
 ITEM
2.  PROPERTIES.
 
 Our
principal executive offices are located at 707 Alexander Road, Building 2, Suite
208, Princeton, New Jersey 08540-6331.  Our engineering research,
design and development facility is located at 220 Commerce Drive, Suite 300,
Fort Washington, Pennsylvania 19034, where we lease approximately 2,513 square
feet of general office space under a lease agreement that terminates in November
2010.   We maintain a marketing office at Three Crystal Park,
2231 Crystal Drive, Suite 1005, Arlington, Virginia.   Since
February 1, 2009, we have also maintained a facility at 8076 114th Ave N.,
Largo, FL 33777 which will support production of our Advanced Diagnostic
Electronic Portable Testset (ADEPT) product line and quality assurance, field
support, and life cycle management.  We believe that our office space
is adequate to support our current and anticipated operations over the next 12
months.
  12
 
 ITEM
3.  LEGAL PROCEEDINGS.
 
 None.
 
 ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
 None.
 
 PART
II
 
 ITEM
5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES.
 
 Our
common stock is quoted on the OTC Bulletin Board under the trading symbol
“MKRS.OB”.  The following table sets forth the range of high and low
bid prices of our common stock for the periods indicated as reported by the OTC
Bulletin Board.  The quoted prices represent only prices between
dealers on each trading day as submitted from time to time by certain of the
securities dealers wishing to trade in our common stock, do not reflect retail
mark-ups, mark-downs or commissions, and may differ substantially from prices in
actual transactions.
 
 BidHigh
              Low2008First
      Quarter
              $
      0.72
              $
      0.51Second
      Quarter
              0.60
              0.45Third
      Quarter
              0.45
              0.26Fourth
      Quarter
              0.40
              0.18
 
 2007First
      Quarter
              $
      0.500
              $
      0.340Second
      Quarter
              0.920
              0.370Third
      Quarter
              0.930
              0.460Fourth
      Quarter
              0.617
              0.432
 
 The last
price of our common stock as reported on the OTC Bulletin Board as of
March  24, 2009 was $0.20 per share.
 
 Dividends
 
 We have
never paid cash dividends on our common stock.   Any payment of
cash dividends in the future will depend upon our earnings (if any), financial
condition, and capital requirements.  Our secured loan agreement with
Sun National Bank prohibits us from paying any dividends on our common
stock.  Certain provisions of our convertible preferred stock also
prohibit us from declaring or paying dividends on our common stock. The declaration and
payment of dividends on our common stock is subject to the discretion of our
board of directors and to certain contractual restrictions and limitations
imposed under the DGCL.  We do not anticipate paying dividends in the
foreseeable future.
 
 As of
March 24, 2009, we had 396 holders of record of our common stock.
  13
 
 ITEM
7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION.
 
 This
Management’s Discussion and Analysis of Financial Condition And Results Of
Operation and other parts of this Annual Report on Form 10-K contain
forward-looking statements that involve risks and uncertainties.  All
forward-looking statements included in this Annual Report on Form 10-K are based
on information available to us on the date hereof, and except as required by
law, we assume no obligation to update any such forward-looking
statements.  Our actual results may differ materially from those
anticipated in these forward-looking statements as a result of a number of
factors, including those set forth under the caption “Risk Factors” beginning on
page 9 of this report and elsewhere herein.  The following should
be read in conjunction with our annual financial statements contained elsewhere
in this report.
 
 Overview
 
 Our
primary business focus is to pursue Small Business Innovation Research (SBIR)
programs from the U.S. Department of Defense, Department of Homeland Security,
and other governmental authorities, and to expand this government funded
research and development into products, services, and business areas of the
Company.  Since 2002, we have been awarded a number of Phase I, II,
and III SBIR contracts.
  Revenues
from our government contracts represented 100% of our revenues for the years
ended December 31, 2008 and 2007.  We believe that we can utilize the
intellectual property developed under our various SBIR awards to develop
proprietary products for both the government and commercial
marketplace.
  Contracts
  In 2008,
we were awarded a number of SBIR contracts related to our ADEPT, WLAN and RWSE
programs.  These included:
 
 ·
              $800,000
      modification to our contract with NSWCPHD for additional 8 ADEPT LRIP
      units and additional logistics development
work.
 ·
              $100,000
      contract  related to our RWSE
program
 ·
              $50,000
      contract  related to our RWSE
program
 
 We are
currently in the process of seeking additional SBIR awards related to the
further development of our existing programs.
 
 Key
Performance Indicator
  As
substantially all of our revenue is derived from SBIR contracts with the federal
government, our key performance indicator is the dollar volume of contracts
awarded to us.  Increases in the number and value of contracts awarded
will generally result in increased revenues in future periods and assuming
relatively stable variable costs associated with our fulfilling such contracts,
increased profits in future periods.  The timing of such awards is
uncertain as we sell to federal government agencies where the process of
obtaining such awards can be lengthy and at times uncertain.
  Competition
in the SBIR arena is intense, and we compete against numerous small businesses
for SBIR awards.  We believe that the primary competitive factors in
obtaining SBIR contracts are technical expertise, prior relevant experience, and
cost. Our history of completing projects in a timely and efficient manner as
well as the experience of our management and technical personnel position us
well to compete for future SBIR grants.
  14
 
 Outlook
 
 Our
strategy for continued growth is three-fold.  First, we expect to
continue expanding our technology base, backlog and revenue by continuing our
active participation in the DoD SBIR program and bidding on projects that fall
within our areas of expertise.  These areas include electronic systems
engineering and integration, radar systems engineering, combat/C4I (Command,
Control, Communications, Computers & Intelligence) systems engineering, and
communications engineering.  We believe that we can utilize the
intellectual property developed under our various SBIR awards to develop
proprietary products, such as the ADEPT® described beginning on Page 4, with
broad appeal in both the government and commercial marketplace.  This
state-of-the-art test equipment can be used by many commercial and governmental
customers such as the FAA, radio and television stations, 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 system
contractors.  Our strategy is to develop these relationships into
longer-term, key subcontractor roles on future major defense programs awarded to
these prime contractors.
 
 In 2009,
our primary strategic focus will be to continue to: (i) establish ourselves as a
premium provider of research and development and product development
services to the defense industry; and (ii) grow our business, generate profits
and increase our cash reserves through obtaining additional SBIR contracts and
positioning the company to obtain future SBIR contracts.  From an
operational prospective, we expect to focus substantial resources on generating
sales of our ADEPT product.  We intend to capitalize on the Navy
modernization program which could result in two or three ADEPT units being
placed on each destroyer and cruiser in the U.S. Navy, with the potential to
install multiple units on additional U.S. Navy ships and
submarines.
  Over the
longer term, we expect to further develop technology based on existing and
additional SBIR contracts and to develop these technologies into products for
wide deployment to Department of Defense customers and contractors as well as
developing potential commercial applications. As an example, we recently
entered into a memorandum of understanding with a global provider of
telecommunications equipment and related services pursuant to which we will
assist the global provider in marketing its products to the DoD.
 
 Critical
Accounting Policies and Estimates
 
 The
discussion and analysis of our financial condition and results of operations are
based upon our financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of
America.  The preparation of these financial statements requires us to
make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. On an on-going basis, we evaluate our estimates, including
those related to bad debts, recoverability of long-lived assets, income taxes
and commitments.  We base our estimates on historical experience and
on various other assumptions that we believe to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from
other sources. Actual results may differ from these estimates under different
assumptions or conditions.  The accounting estimates and assumptions
discussed in this section are those that we consider to be the most critical to
an understanding of our financial statements because they inherently involve
significant judgments and uncertainties.
  Revenue
Recognition
 
 We are
engaged in research and development contracts with the Federal Government to
develop certain technology to be utilized by the US Department of Defense. The
contracts are cost plus fixed fee contracts and the Company accounts for these
contracts within the scope of Chapter 11 of Accounting Research Bulletin No. 43,
Government Contracts or Statement of Position 81-1, Accounting for Performance
of Construction-Type and Certain Production-Type Contracts using the
percentage-of -completion accounting method. Under this method, revenue is
recognized based on the extent of progress towards completion of the long term
contract.
  15
 
 We
generally use a variation of the cost to cost method to measure progress for all
long term contracts unless we believe another method more clearly measures
progress towards completion of the contract.
  Revenues
are recognized as costs are incurred and include estimated earned fees, or
profit, calculated on the basis of the relationship between costs incurred and
total estimated costs at completion.
 
 Unbilled
revenue reflects work performed, but not billed at the time, per contractual
requirements.   Billings to customers in excess of revenue earned
are classified as advanced billings, and shown as a
liability.
  Accounts
receivable
  Accounts
receivable from Government Contracts are stated at outstanding balances, less an
allowance for doubtful accounts, if necessary.  When necessary, the
allowance for doubtful accounts is established through provisions charged
against operations.  Receivables deemed to be uncollectible are
charged against the allowance and subsequent recoveries, if any, are credited to
the allowance.
 
 The
allowance for doubtful accounts is maintained at a level considered adequate to
provide for losses that can be reasonably anticipated. Management’s periodic
evaluation of the adequacy of the allowance is based on past experience, aging
of the receivables, adverse situations that may affect a customers’ ability to
pay, current economic conditions and other relevant factors.  This
evaluation is inherently subjective as it requires estimates that may be
susceptible to significant change.  Unpaid balances remaining after
the stated payment terms are considered past due.  No allowance for
doubtful accounts was deemed necessary by management at December 31, 2008 and
2007.
 
 Income
taxes
 
 We
account for income taxes in accordance with SFAS 109, Accounting for Income Taxes.
Under SFAS 109, deferred tax assets and liabilities are determined based on
the differences between the financial statement carrying amounts and the tax
bases of existing assets and liabilities, and are measured at the prevailing
enacted tax rates that will be in effect when these differences are settled or
realized. SFAS 109 also requires that deferred tax assets be reduced by a
valuation allowance if it is more likely than not that some portion or all of
the deferred tax asset will not be realized.
 
 Stock
Options
 
 We
havea fixed stock
option plan which is described in Note 5 of our financial statements to provide
for the grant of stock options to eligible employees and directors.
 
 Effective
January 1, 2006, we adopted the fair value recognition provisions of FASB
Statement No. 123(R), “Share Based Payment,” using the modified-prospective
transition method.  Under that transition method, compensation cost
recognized after January 1, 2006 includes: (a) compensation cost for all
share-based payments granted prior to, but not yet vested, as of January 1, 2006
based on the grant-date fair value calculated in accordance with the provision
of Statement No. 123(R), and (b) compensation cost for all share-based payments
granted subsequent to December 31, 2005, based on the grant-date fair value
calculated in accordance with the provision of Statement 123(R).  We
had no unvested stock options at December 31, 2005, therefore, the adoption of
Statement 123(R) relates only to share-based payments granted after January 1,
2006.
 
 16
  Recently
Issued Accounting Standards
 
 In November 2008, the SEC
released a proposed roadmap regarding the potential use by U.S. issuers of
financial statements prepared in accordance with International Financial
Reporting Standards (IFRS).  IFRS is a comprehensive series of
accounting standards published by the International Accounting Standards Board(“LASB”). Under the proposed roadmap, the Company may be required to
prepare financial statements in accordance with IFRS as early as
2014.  The SEC will make a determination in 2011 regarding the
mandatory adoption of IFRS.  The Company is currently assessing the
impact that this potential change would have on its financial statements, and it
will continue to monitor the development of the potential implementation of
IFRS.
 
 In June
2008, the Emerging Issues Task Force (“EITF”) ratified Issue No. 07-5,
“Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity’s Own Stock” (“EITF 07-5”).  EITF 07-5 clarifies how to
determine whether certain instruments or features were indexed to an entity’s
own stock.   The consensus will replace EITF 01-6 as a critical
component of the literature applied to evaluating financial instruments for debt
or equity classification and embedded features for bifurcation as
derivatives.  EITF 07-5 will become effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years.  The Company is currently analyzing the
impact on the Company’s Financial Statements.
  In
May 2008, the FASB issued Statement No. 162, “The Hierarchy of
Generally Accepted Accounting Principles” (“SFAS No. 162”).  SFAS No. 162
identifies the sources for GAAP and lists the categories in descending
order.  An entity should follow the highest category of GAAP applicable for
each of its accounting transactions.  SFAS No. 162 is effective 60 days
following the SEC’s approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles.” The adoption of SFAS No. 162 will not
have a material effect on the Company’s financial statements.
  In
February 2007, the FASB issued SFAS No. 159, “Fair Value Option for Financial
Assets and Liabilities” (“SFAS No. 159”).  SFAS No. 159 allows
companies to choose, at specific election dates, to measure eligible financial
assets and liabilities that are not otherwise required to be measured at fair
value, at fair value.  Under SFAS No. 159, companies would report
unrealized gains and losses for which the fair value option has been elected in
earnings at each subsequent reporting date, and recognize up-front costs and
fees related to those items in earnings as incurred.  SFAS No. 159
became effective for fiscal years beginning after November 15,
2007.  The Company adopted  SFAS No. 159 during 2008 and
elected not to measure any financial assets or liabilities at fair
value.
 
 In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
No. 157”).  SFAS No. 157 establishes a common definition for fair
value to be applied to U.S. GAAP requiring use of fair value, establishes a
framework for measuring fair value, and expands disclosure about such fair value
measurements. SFAS No. 157 is effective for financial assets and financial
liabilities for fiscal years beginning after November 15, 2007. Issued in
February 2008, FSP 157-1 “Application of FASB Statement No. 157 to FASB
Statement No. 13 and Other Accounting Pronouncements That Address Fair Value
Measurements for Purposes of Lease Classification or Measurement under Statement
13” removed leasing transactions accounted for under Statement 13 and related
guidance from the scope of SFAS No. 157. FSP 157-2 “Partial Deferral of the
Effective Date of Statement 157” (“FSP 157-2”), deferred the effective date of
SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities to fiscal
years beginning after November 15, 2008.  FSP 157-3 “Determining the
Fair Value of a Financial Asset When the Market for That Asset Is Not Active”
(“FSP 157-3”) was released in October 2008 and was effective upon issuance. FSP
157-3 clarifies the application of SFAS 157 in a market that is not
active.  The implementation of SFAS No. 157 for financial assets and
financial liabilities, effective January 1, 2008, did not have a material impact
on the Company’s financial statements. The Company does not expect the adoption
of SFAS No. 157 for nonfinancial assets andnonfinancial
liabilities to have a material impact on its financial
statements.
  17
 
 In
November 2007, the EITF reached a consensus on EITF 07-1: “Accounting for
Collaborative Arrangements” (“EITF 07-1”).   EITF No. 07-01
provides guidance for whether an arrangement constitutes a collaborative
arrangement, how costs incurred and revenue generated on sales to third parties
should be reported by the partners to a collaborative arrangement in each of
their respective income statements, how payments made to or received by a
partner pursuant to a collaborative arrangement should be presented in the
income statement, and what participants should disclose in the notes to the
financial statements about a collaborative arrangement. EITF 07-1 shall be
effective for annual periods beginning after December 15, 2008. Entities
are required to report the effects of applying EITF 07-1 as a change in
accounting principle through retrospective application to all periods to the
extent practicable. Upon application of EITF 07-1, the following is
required to be disclosed: a) a description of the prior-period information
that has been retrospectively adjusted, if any, and b) the effect of the
change on revenue and operating expenses (or other appropriate captions of
changes in the applicable net assets or performance indicator) and on any other
affected financial statement line item. The Company does not expect the adoption
of EITF 07-1 to have a material impact on its financial
statements.
  In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“SFAS No. 141(R)”).  SFAS No. 141(R) significantly
changes the accounting for business combinations. Under SFAS No. 141(R), an
acquiring entity will be required to recognize all the assets acquired and
liabilities assumed in a transaction at the acquisition-date at fair value with
limited exceptions.  SFAS No. 141(R) further changes the accounting
treatment for certain specific items, including:
 
 §
              Acquisition
      costs will be generally expensed as
incurred;
  §
              Noncontrolling
      interests (formerly known as “minority interests”) will be recorded at
      fair value at the acquisition date;
  §
              Acquired
      contingent liabilities will be recorded at fair value at the acquisition
      date and subsequently measured at either the higher of such amount or the
      amount determined under existing guidance for non-acquired
      contingencies;
  §
              In-process
      research and development (IPR&D) will be recorded at fair value as an
      indefinite-lived intangible asset at the acquisition
  date;
  §
              Restructuring
      costs associated with a business combination will be generally expensed
      subsequent to the acquisition date;
and
  §
              Changes
      in deferred tax asset valuation allowances and income tax uncertainties
      after the acquisition date generally will affect income tax
      expense.
  SFAS No.
141(R) includes a substantial number of new disclosure requirements. SFAS No.
141(R) applies prospectively to business combinations for which the acquisition
date is on or after January 1, 2009.
 
 In March
2007 the EITF reached a consensus on EITF 07-3: “Accounting for Nonrefundable
Advance Payments for Goods or Services Received for Use in Future Research and
Development Activities” (“EITF 07-03”).  EITF 07-3 guidance states
that nonrefundable advance payments for goods or services that will be used or
rendered for future research and development activities should be deferred and
capitalized. Such amounts are required to be recognized as an expense as the
related goods are delivered or the related services are performed. Entities
should continue to evaluate whether they expect the goods to be delivered or
services to be rendered. If an entity does not expect the goods to be delivered
or services to be rendered, the capitalized advance payment should be charged to
expense.  EITF 07-1 became effective as of January 1, 2008 and
applies prospectively for new contracts. The adoption of EITF 07-3 did not have
a material impact on the Company’s consolidated financial
statements.
 
 Results
of Operations
 
 Years ended December 31,
2008 and 2007
 
 Total
contract revenues in 2008 were $3,098,264 compared to $3,078,492 in 2007, an
increase of $19,772 or .6%.  Contract revenues in both years were
derived entirely from SBIR contracts.  Based on current backlog and
outstanding bids, we expect revenue to increase in future periods.
  Cost of
sales consist of direct contract costs such as labor, material, subcontracts,
travel, and other direct costs.   Cost of sales were $1,628,388
in 2008 compared to $1,828,184 in 2007, a decrease of $199,796 or approximately
10.9%.  The decrease consists of higher direct labor and contract
material costs, offset by substantially lower subcontract and other direct
costs.
  18
  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 expenses
were $578,105 in 2008 compared to $436,104 in 2007, an increase of $142,001 or
32.6%.  The increase in engineering costs in 2008 was primarily due to
additional indirect engineering labor costs, incentive compensation costs,
payroll taxes and medical benefits.
 
 General
and administrative expenses consist primarily of salary, consulting fees paid to
bid and proposal consultants and related costs, professional fees, business
insurance, franchise tax, SEC compliance costs, travel, and unallowable expenses
(representing those expenses for which the government will not reimburse
us).  General and administrative expenses were $761,428 in 2008
compared to $651,155 in 2007, an increase of $110,273 or 16.9%.  The
increase in 2008 was due primarily due to increases in indirect research and
development labor costs, incentive compensation costs, increases in bid and
proposal costs, administrative labor costs, and non cash expenses related to
stock option compensation.
 
 The
provision for income taxes was $78,261 in 2008 compared to $2,781 for 2007,
representing an effective income tax rate of 58.7%, and 1.6%,
respectively.  During 2008, the increase in the effective federal income
tax rate is attributable to state income taxes and income tax related to
permanent differences.  During 2007, the decrease in the effective federal
income tax rate was primarily attributable to a reduction in the valuation
allowance against a deferred federal tax asset resulting from the utilization of
federal net operating loss carryovers, which was partially offset by income tax
related to permanent differences and state income taxes.
  We
generated net income of $55,099 in 2008 as compared to $165,811 in 2007, a
decrease of  $110,712 or  66.8%.   The
decrease in net income was due to the delay in receiving contracts from the
Federal Government and increased operating expenses.   The delay
in receiving contracts resulted in an increase in operating costs which we
absorbed in the form of higher engineering and general and administrative
costs.   Certain of these contracts are expected to be awarded in
2009 at which time, we expect to recognize revenue without corresponding
increases in engineering and general and administrative costs.
 
 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.
 
 At
December 31, 2008, we had cash and cash equivalents amounting to $608,530
and  net working capital of $554,352.  During the year ended
December 31, 2008, we generated $203,973 of cash flow from operating activities
compared to $185,873 in 2007.  The increase was attributable to
changes in working capital items; primarily a decrease in accounts receivable
offset by decreases in accounts payable.
 
 On
January 9, 2009, we entered into a $50,000 line of credit agreement with Sun
National Bank (“Sun”).  The line of credit will be available to us for
one year.  The line of credit is secured by a $50,000 Certificate of
Deposit with Sun.
 
 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.
  19
 
 Off-Balance Sheet
Arrangements
 
 As of
December 31, 2008, 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.
 
 ITEM
8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
 The
financial statements required to be filed pursuant to this Item 8 are appended
to this report beginning on page 35 located immediately after the signature
page.
 
 ITEM
9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
 
 None.
 
 ITEM
9A(T). CONTROLS AND PROCEDURES.
 
 Disclosure Controls and
Procedures.
 
 An
evaluation of the effectiveness of our disclosure controls and procedures (as
defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of
1934) 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 December 31, 2008, 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 SEC’s rules and forms and (ii) that such information is accumulated and
communicated to management, including our president, in order to allow timely
decisions regarding required disclosure.
 
 Management’s Report on
Internal Control over Financial Reporting.
 
 Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rule 13a-15(f) of the Securities
Exchange Act of 1934.  Our internal control system was designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial reporting and the preparation of financial
statements for external purposes, in accordance with generally accepted
accounting principals.  Because of its inherent limitations, internal
control over financial reporting may not prevent or detect
misstatements.  Also, projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.
 
 Our
management, including our president, conducted an evaluation of the
effectiveness of internal control over financial reporting using the criteria
set forth by the Committee of Sponsoring Organizations of the Treadway
Commission in Internal Control – Integrated Framework.  Based on its
evaluation, our management concluded that our internal control over financial
reporting was effective as of December 31, 2008.
 
 This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial
reporting.  Management’s report was not subject to attestation by our
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit us to provide only management’s report in
this annual report.
  20
 
 Changes in Internal Control
Over Financial Reporting.
 
 There
have not been any changes in our internal control over financial reporting (as
defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act )
that occurred during the fiscal quarter ended December 31, 2007 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
 
 ITEM
9B.  OTHER INFORMATION.
 
 None.
  PART
III
 
 ITEM
10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE.
 
 The
current members of our Board of Directors and executive officers of our Company
are as follows:
 
 Name
              Age
              Positions
      with the CompanyPaul
      G. Casner
              71
              DirectorThomas
      C. Lynch
              66
              DirectorThomas
      J. Meaney
              74
              President,
      Chief Financial Officer, and DirectorWayne
      E. Meyer
              82
              Chairman
      of the Board of DirectorsTom
      L. Schaffnit
              62
              DirectorWalter
      T. Bristow
              51
              Vice
      President of EngineeringHenry
      Silcock
              56
              Chief
      Technology OfficerMarc
      Dalby
              44
              Vice
      President, Business Development and Program ManagementPatricia
      A. Kapp
              42
              Secretary
      and Treasurer
  The
principal occupation and business experience, for at least the past five years,
of each current director and executive officer is as follows:
 
 Paul G. Casner, Jr. has been a
director of the Company since May 2002.From 1999 to March 2005,
Mr. Casner served as Executive Vice President and Chief Operating Officer of DRS
Technologies, Inc.  From 1994 to 1998, Mr. Casner served as President
of the Electronic Systems Group of DRS Technologies. Before joining DRS
Technologies, Mr. Casner was the Chairman and Chief Executive Officer of
Technology Applications and Service Company.  Mr. Casner has
over  40  years of Defense Industry experience, including
several senior positions in Business Management, Technical Management, Strategic
Planning and Business Development. He is a member of the Naval Reserve
Association and is a Commodore of the Navy League of the United States, in
addition to other professional affiliations. Mr. Casner serves on theboards of
Integral Systems Inc., Aurora Flight Sciences, and Atair Aerospace Systems.
 
 Thomas C. Lynch has been a
Director of the Company since February 1997.  Mr. Lynch is currently
Managing Director of The Musser Group and an active Consultant for Jones Lang
LaSalle formerlyThe Staubach Company.
 Mr. Lynch served as Senior Vice President of Safeguard Scientifics, Inc.
from 1998 to August 2000 and he was Executive Vice President and later became
President and Chief Operating Officer of CompuCom Systems, Inc, a Safeguard
subsidiary.  Mr. Lynch, a retired Navy Admiral, serves as a Director on the
following boards:  InfoLogix, Epitome Systems, Telkonet, Armed Forces
Benefit Association, Catholic Leadership Institute, National Center for the
American Revolution at Valley Forge, and USO World Board of Governors.  He
has served as President of Valley Forge Historical Society and Chairman of the
Cradle of Liberty Council, Boy Scouts of America. He currently serves as a
Chairman of the US Naval Academy Athletic & Scholarship
Foundation.
  21
 
 Thomas J. Meaney has been a
Director of the Company since July 1986 and was Chairman of the Board from June
1997 until February 1999. He was appointed President in June 1986 and continued
to serve until February 1997.  On September  30, 1998, he
was reappointed President of the Company.  From February 1983 to June
1986, Mr. Meaney was Senior Vice President and Director of Robotic Vision
Systems Incorporated (“RVSI”), a manufacturer of robotic vision
systems.  Mr. Meaney served as a Director of RVSI until
1991.  Prior to 1983 and for more than five years, he was Vice
President - Business Development, International of Norden Systems and President
- Norden Systems Canada, both divisions of United Technologies Corporation and
developers of computer and electronic products and systems.  He
presently owns his own defense consulting company with offices in Arlington,
Virginia and Chadds Ford, Pennsylvania.  Mr. Meaney is also a director
of Ocean Power Technologies, Inc., a public company listed on
Nasdaq.
  Wayne E. Meyer has been a
Director of the Company since April 1988, Chairman of the Board 1990 to 1997,
and re-elected as Chairman in February 1999. From 1986 to present, he has been
the Founder and President of the W.E. Meyer Corporation, based in Arlington,
Virginia. The company engages in consulting and advice to industry, government
and academic institutions in matters of systems engineering, project management,
strategic planning and military and electronic designs.  He enlisted
in the U.S. Navy as an Apprentice Seaman in 1943 and retired in 1985 in the rank
of  Rear Admiral.  As a national authority on Ballistic
Missile Defense, he serves on numerous boards, groups and panels.
 
 Tom L. Schaffnit has been a
Director of the Company since June 2000.  Since March 1999, he has been
President of Schaffnit Consulting, Inc., a technology-related management
consulting company specializing in vehicle safety communications, automotive
telematics, and wireless data communications.  He was previously President
of CUE Data Corporation, responsible for creating and implementing new
datacasting services on a nationwide wireless network.  Previously, he
served as a Senior Manager with Deloitte & Touche Consulting Group, and as
Director with Nordicity Group. Mr. Schaffnit remains actively involved in the
evolution of wireless technologies and standards. He is currently Chairman of
the SAE DSRC Technical Committee, which is developing standard message sets for
vehicle-to-vehicle and vehicle-to-infrastructure wireless
communications.
  Walter T. Bristow has been
Vice President of Engineering since August 2007.  Prior to that, he
served as our Director of Engineering since October 2003.  Prior to
Mikros, Mr. Bristow served as the Director of Network Engineering for Clariti
Telecommunications International, responsible for wireless network development
and implementation, software engineering, corporate telecommunication, and
information technology.   Prior to Clariti, Mr. Bristow spent 13 years
with Magnavox/General Atronics Corporation, a manufacturer of military
communications equipment, where he worked in hardware engineering, integration,
and design for state-of-the-art military radio communications
equipment.
 
 Marc Dalbyhas been Vice
President, Business Development and Program Management since February,
2009.  Prior to that, he served as our Director of Program Development and has
been with the company since November 2007. Prior to Mikros, Mr. Dalby served as
Vice President of Business Systems and Strategy for London Bridge Trading
Company, a Virginia manufacturing firm. Prior to London Bridge, Mr. Dalby
was Vice President, Contracts and Sales Channel Development for ADS, Inc., a
Virginia distribution and logistics management firm. He has held other
senior-level program management and business development positions in both
technology and services-oriented organizations, including DRS
Technologies.
 
 Henry Silcockhas been Chief
Technology Officer since February, 2009.  Since 2003,
Mr. Silcockserved as our Senior
Staff Engineer.  Mr. Silcock was technical lead and program manager on
several Mikros wireless R&D projects, including the RWSE program which
incorporated EMC analysis capabilities into the AIRchitect wireless network
design and optimization tool; the KCVA program, which is developing simulation
tools for weapons data link analysis; and several wireless application programs
developing shipboard networks.  Mr. Silcock was formerly lead engineer
on a number of successful R&D programs, including frequency-diversity modems
for tactical radio networks, telemetry networks for ocean-going buoys and
digital voice pager design and development.  He also has experience in
network and system simulation, software and microprocessor architecture, custom
VSLI development, DSP and real-time systems, and as CTO of a short-lived
Internet startup.
  Patricia A. Kapp has been
Corporate Secretary of the Company since April 1996.  In September
1998, Ms. Kapp was also named Treasurer.  Ms. Kapp has served in various
capacities with the Company since 1987.
  22
  Section 16(a) Beneficial
Ownership Reporting Compliance
 
 Section
16(a) of the Exchange Act requires our directors, officers and stockholders who
beneficially own more than 10% of any class of our equity securities registered
pursuant to Section 12 of the Exchange Act to file initial reports of ownership
and reports of changes in ownership with respect to our equity securities with
the SEC.  All reporting persons are required by SEC regulation to
furnish us with copies of all reports that such reporting persons file with the
SEC pursuant to Section 16(a).  Based solely on our review of the
copies of such forms received by us and upon written representations of such
reporting persons, we believe that all reporting persons are in compliance with
all Section 16(a) filing requirements applicable to such reporting
persons.
 
 Audit
Committee
 
 In March
2004, the board of directors formed an Audit Committee. The members of the Audit
Committee are Tom L. Schaffnit (Chair), Thomas C. Lynch, Wayne E. Meyer, and
Paul G. Casner, Jr.  The Audit Committee oversees and monitors
management’s and the independent outside auditors’ participation in the
accounting and financial reporting processes and the audits of the financial
statements of the Company.  The Audit Committee has the responsibility
to appoint, compensate, retain and oversee the work of the outside independent
auditors and to consult with the independent auditors and the appropriate
officers of the Company on matters relating to outside auditor independence,
corporate financial reporting, accounting procedures and policies, adequacy of
financial accounting and operating controls, and the scope of audits. The Audit
Committee is governed by an Audit Committee Charter, which was adopted on March
10, 2004 and amended on March 17, 2008 and February 9, 2009.
 
 Since our
inception, we have had a limited number of employees and generated limited
revenues, most of which have been from a single customer.  In light of
the foregoing, and the need to conserve our financial resources to execute our
business plan, our Board of Directors concluded that the benefits of retaining
an individual who qualifies as an “audit committee financial expert,” would be
outweighed by the costs of retaining such a person.  As a result, no
member of our Board of Directors qualifies as an “audit committee financial
expert.”
 
 Code of
Ethics
 
 We have
adopted a written code of ethics that applies to our directors, officers and
employees, including our principal executive officer, principal financial
officer, principal accounting officer or controller, or persons performing
similar functions.   Our Code of Business Conduct and Ethics is
also available on our website, www.mikros.us, or without charge upon written
request directed to Patricia A. Kapp, Secretary, Mikros Systems Corporation, 707
Alexander Road, Building Two, Suite 208, Princeton, New Jersey
08540.
 
 ITEM
11.  EXECUTIVE COMPENSATION
 
 The
following table provides certain summary information concerning compensation
earned by the executive officers named below (“named executive officers”) during
the fiscal years ended December 31, 2008 and 2007.
 
 SUMMARY
COMPENSATION TABLE
  Name
      andPrincipal
      Position
              Year
              Salary
    ($)
              Option
                Awards ($)(1)
              Total
  ($)Thomas
      J. Meaney
              2008
              177,650
              2,178
              179,828President, Chief
      Executive Officer and Chief Financial Officer
              2007
              120,300
              544
              120,844Walter
      T. Bristow
              2008
              139,264
              3,259
              142,523Vice  President
      of Engineering
              2007
              129,778
              815
              130,593
 (1)
              The
      assumptions used in calculating the value of the option awards and the
      amount recognized for financial statement reporting purposes in 2008 is
      located in Note 2 of our financial
statements.
  23
  OUTSTANDING
EQUITY AWARDS AT FISCAL YEAR−END
 
 The
following table sets forth information regarding unexercised stock options for
each named executive officer outstanding as of December 31, 2008:
 
 Name
              Number
      of securities
                underlying
      unexercised
                options(#)exercisable
              Number
      of securities
                underlying
      unexercised
                options(#)unexercisable
              Option
                exercise
                price($)
              Option
                expiration
                dateThomas
      J. Meaney
              8,333
              16,667
      (1)
              0.55
              10/3/17Walter
      T. Bristow
              10,000
              40,000
      (2)
              0.55
              10/3/17
 (1)
              The
      stock options were granted on October 3, 2007 and vest in equal annual
      installments over a three year period commencing on the date of
      grant.
 (2)
              The
      stock options were granted on October 3, 2007 and vest in equal annual
      installment over a five year period commencing on the date of
      grant.
  Narrative Disclosure to
Summary Compensation and Outstanding Equity Awards Tables
 
 On
October 3, 2007, we issued options to Mr. Meaney and Mr. Bristow under the 2007
Stock Incentive Plan to purchase 25,000 and 50,000 shares of common stock,
respectively, at an exercise price of $0.55 per share,the last
sales price of our common stock as reported on the OTCBB on the date of
grant.  Mr. Meaney’s options vest in three equal annual installments
and terminate ten years from the date of grant.   Mr. Bristow’s
options vest in five equal annual installments and terminate ten years from the
date of grant.  For a more complete description of the terms and
conditions of these options, including a description of the change in control
provisions, please see “2007
Stock Incentive Plan” in Item 11 below.
 
 On December 19, 2007 we revised our
arrangement with Mr. Meaney, who apportions his professional time between the
Company and his consulting firm which provides services to various defense
contractors.   In recent years, he has devoted approximately 50%
of his professional time to the Company.  In light of the resignation
of our Executive Vice President on September 1, 2007, the growth of the Company
in 2007, and the importance of Mr. Meaney to both  our operations and
continued growth, Mr. Meaney has been required to and is expected to continue to
devote substantial additional time and attention to the Company.  In
recognition of the forgoing, effective January 1, 2008, we
expected  that Mr. Meaney would devote approximately 75% of his
professional time to the Company and that his annual compensation would increase
from approximately $105,000 in 2007 to approximately $160,000 in
2008.  We expect that Mr. Meaney will continue to devote approximately
75% of his professional time to the Company.
  24
 
 The options issued to Mr. Meaney and
Mr. Bristow were issued under our 2007 Stock Incentive Plan which provides for
certain benefits upon a change in control of the
Company.  Specifically, upon the occurrence of a "reorganization
event", defined as the merger of the Company with or into another corporation as
a result of which our common stock is converted into or exchanged for cash,
securities or other property or is cancelled, the exchange of all shares of our
common stock for cash, securities or other property pursuant to a share
exchange, or the liquidation of the Company, the Board may take any number of
actions.  These actions include, providing for all options outstanding
under the Plan to be assumed by the acquiring corporation or to become
immediately vested and exercisable in full, and in the case of a reorganization
event in which holders of our common stock receive a cash payment, to provide
for a cash payment to holders of options equal to the excess, if any, of the per
share cash payment over the exercise price of such options.
 
 COMPENSATION
OF DIRECTORS
 
 The
following table sets forth the compensation for 2008 for those persons who
served as members of our Board of Directors during 2008:
 
 Name
      (1)
              Fees
      earned
                or
      paid
                in
      cash
                ($)
              Option
                Awards
      (2)
                ($)
              Total
                ($)Wayne
      E. Meyer
              5,000
              2,178
      (3)
              7,178Paul
      G. Casner
              5,000
              2,178
      (3)
              7,178Thomas
      C. Lynch
              5,000
              2,178
      (3)
              7,178Tom
      L. Schaffnit
              5,000
              2,178
      (4)
              7,178
 (1)
              Thomas
      J. Meaney is not listed in the above table because he did not receive any
      compensation for serving on our board of directors in
  2008.
 (2)
              The
      assumptions used in calculating the value of the option awards and the
      amount recognized for financial statement reporting purposes in 2008 is
      located in Note 2 of our consolidated financial
  statements.
 (3)
              As
      of December, 31, 2008, Messrs. Meyer, Casner and Lynch each owned an
      option to purchase 25,000 shares of our common stock at an exercise price
      of $0.55 per share.
 (4)
              As
      of December 31, 2008, Mr. Schaffnit owned options to purchase 361,818 and
      25,000 shares of common stock at exercise prices of $0.1658 and $0.55 per
      share, respectively.
 
 Narrative Disclosure To
Director Compensation Table
 
 We pay an
annual fee of $5,000 to each of our directors who is not an employee of the
Company.  Each member of our board of directors receives reimbursement
of expenses incurred in connection with his services as a member of our board or
board committees.
On October 3, 2007, we issued options to each member of our board of directors
under the 2007 Stock Incentive Plan to purchase 25,000 shares of common
stock  at an exercise price of $0.55 per share, the last sales price
of our common stock as reported on the OTCBB on the date of
grant.  The options vest in three equal annual installments and
terminate ten years from the date of grant.  For a more complete
description of the terms and conditions of these options, including a
description of the change in control provisions, please see “2007 Stock Incentive Plan”in
Item 12 below.
  25
 
 ITEM
12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS.
 
 Common
Stock
 
 The
following table sets forth certain information, as of March 24, 2009 with
respect to holdings of our common stock by (i) each person known by us to be the
beneficial owner of more than 5% of the total number of shares of common stock
outstanding as of such date, (ii) each of our directors and executive officers,
and (iii) all directors and executive officers as a group.  Except as
otherwise indicated, the address of each person is 707 Alexander Road, Suite
208, Princeton, New Jersey 08540.
  Name
      ofBeneficialOwner
              Amount
      and
                Nature  of
      Beneficial
                Ownership
      (1)
              Percent
                of
                Class5%
      Beneficial Owners:Princeton Valuation
      Consultants, L.L.C.

                5
      Vaughn Drive Princeton, New Jersey 08540
              2,920,050(2)
              8.9%Directors
      and Executive Officers:Walter
      T. Bristow
                220
      Commerce Drive, Suite 300
                Fort
      Washington, Pennsylvania 19034
              23,000(3)
              *Paul
      G. Casner
              406,733(4)
              1.2%Patricia
      A. Kapp
              173,000(3)
              *Thomas
      C. Lynch
              390,733(4)
              1.2%Thomas
      J. Meaney
              5,520,175(5)
              16.5%Wayne
      E. Meyer
              3,079,988(6)
              9.7%Tom
      L. Schaffnit
              1,111,610(7)
              3.4%Henry
      Silcock
              8,000(8)
              *Marc
      Dalby
              --(9)
              -All
      Current Directors and Officers as a Group (nine persons)
              10,713,299
              31.4%
 
 *
              Less
      than 1%
 
 (1)
              The
      beneficial owners and amount of securities beneficially owned have been
      determined in accordance with Rule 13d-3 under the Exchange Act and, in
      accordance therewith, includes all shares of our common stock that may be
      acquired by such beneficial owners within 60 days of March 24, 2009 upon
      the exercise or conversion of any options, warrants or other convertible
      securities.  This table has been prepared based on 31,766,753
      shares of common stock outstanding on March 24, 2009.  Except as
      otherwise indicated, all shares are beneficially owned and the sole
      investment and voting power is held by the persons
  named.
 (2)
              Includes
      202,500 shares issuable upon conversion of Convertible Preferred Stock and
      695,883 shares issuable upon conversion of Series B Convertible Preferred
      Stock.
  26
  (3)
              Includes
      10,000 shares issuable upon exercise of options.  Does not
      include 40,000 shares issuable upon exercise of options subject to
      vesting.
 (4)
              Includes
      8,333 shares issuable upon exercise of options.  Does not
      include 16,667 shares issuable upon exercise of options subject to
      vesting.
 (5)
              Includes
      50,000 shares issuable upon conversion of Convertible Preferred Stock,
      1,949,775 shares issuable upon conversion of Series B Convertible
      Preferred Stock, and 8,333 shares issuable upon exercise of
      options.  Does not include 16,667 shares issuable upon exercise
      of options subject to vesting.
 (6)
              Includes
      30,000 shares issuable upon conversion of Series B Convertible Preferred
      Stock and 8,333 shares issuable upon exercise of options.  Does
      not include 16,667 shares issuable upon exercise of options subject to
      vesting.
 (7)
              Includes
      370,151 shares issuable upon the exercise of options.  Does not
      include 16,667 shares issuable upon exercise of options subject to
      vesting.
 (8)
              Consists
      of shares issuable upon exercise of options.  Does not include
      32,000 shares issuable upon exercise of options subject to
      vesting.
 (9)
              Does
      not include 10,000 shares issuable upon exercise of options subject to
      vesting.
 
 Convertible Preferred
Stock
 
 The
following table sets forth certain information, as of March 24, 2009, with
respect to holdings of our Convertible Preferred Stock by (i) each person known
by us to be the beneficial owner of more than 5% of the total number of shares
of our Convertible Preferred Stock outstanding as of such date, (ii) each of our
directors and executive officers, and (iii) all directors and executive officers
as a group.  Except as otherwise indicated, the address of each person
is 707 Alexander Road, Suite 208, Princeton, New Jersey 08540.
  Nameof
      BeneficialOwner
              Amount
      and
                Nature
      of Beneficial Ownership(1)
              Percent
                Of
                Class5% Beneficial
      Owners:Princeton
      Valuation Consultants L.L.C.
                5
      Vaughn Drive Princeton, New Jersey 08540
              202,500
              79.4%Directors and
      Executive Officers:Walter
      T. Bristow
                220
      Commerce Drive, Suite 300
                Fort
      Washington, Pennsylvania 19034
              --
              --Paul
      G. Casner
              --
              --Patricia
      A. Kapp
              --
              --Thomas
      C. Lynch
              --
              --Thomas
      J. Meaney
              50,000
              19.6%Wayne
      E. Meyer
              --
              --Tom
      L. Schaffnit
              --
              --Henry
      Silcock
              --
              --Marc
      Dalby
              --
              --All
      Current Directors and Officers as a Group (nine persons)
              50,000
              19.6%
 
 (1)
              Except
      as otherwise indicated, all shares are beneficially owned and the sole
      investment and voting power is held by the persons
  named.
 
 27
  Series B Convertible
Preferred Stock
 
 The
following table sets forth certain information, as of March 24, 2009, with
respect to holdings of our Series B Convertible Preferred Stock by (i) each
person known by us to be the beneficial owner of more than 5% of the total
number of shares of our Series B Convertible Preferred Stock outstanding as of
such date, (ii) each of our directors and  executive officers, and
(iii) all directors and executive officers as a group.  Except as
otherwise indicated, the address of each person is 707 Alexander Road, Suite
208, Princeton, New Jersey 08540.
 
 Name
      ofBeneficialOwner
              Amount
      and
                Nature
      of Beneficial Ownership(1)
              Percent
                of
                Class5% Beneficial
      Owners:The
      Mercantile & General Reinsurance Company,
                PLC
      Moorfields House Moorfields London EC2Y 9AL
              91,342
              8.3%Princeton
      Valuation Consultants, L.L.C.
                5
      Vaughn Drive
                Princeton,
      New Jersey 08540
              231,961
              21.0%Directors and
      Executive Officers:Walter
      T. Bristow
                220
      Commerce Drive, Suite 300
                Fort
      Washington, Pennsylvania 19034
              --
              --Paul
      G. Casner
              --
              --Thomas
      C. Lynch
              --
              --Patricia
      A. Kapp
              --
              --Thomas
      J. Meaney
              649,925
              59.0%Wayne
      E. Meyer
              10,000
              *Tom
      L. Schaffnit
              --
              --Henry
      Silcock
              --
              --Marc
      Dalby
              --
              --All
      Current Directors and Officers as a Group (nine persons)
              659,925
              59.0%
 
 * Less
than 1%
 
 (1)
              Except
      as otherwise indicated, all shares are beneficially owned and the sole
      investment and voting power is held by the persons
  named.
 
 28
  Redeemable Series C
Preferred Stock
 
 The
following table sets forth certain information, as of March 24, 2009, with
respect to holdings of our Redeemable Series C Preferred Stock by (i) each
person known by us to be the beneficial owner of more than 5% of the total
number of shares of our Redeemable Series C Preferred Stock outstanding as of
such date, (ii) each of our directors and executive officers, and (iii) all
directors and executive officers as a group.  Except as otherwise
indicated, the address of each person is 707 Alexander Road, Suite 208,
Princeton, New Jersey 08540.
  Name
      ofBeneficialOwner
              Amount
      and
                Nature
      of Beneficial Ownership(1)
              Percent
                of
                ClassDirectors and
      Executive Officers:Walter
      T. Bristow
                220
      Commerce Drive, Suite 300
                Fort
      Washington, Pennsylvania 19034
              --
              --Paul
      G. Casner
              --
              --Patricia
      A. Kapp
              --
              --Thomas
      C. Lynch
              --
              --Thomas
      J. Meaney
              5,000
              100.0%Wayne
      E. Meyer
              --
              --Tom
      L. Schaffnit
              --
              --Henry
      Silcock
              --
              --Marc
      Dalby
              --
              --All
      Current Directors and Officers as a Group (nine persons)
              5,000
              100.0%
 
 *
      Less than 1%
 
 (1)           Except
as otherwise indicated, all shares are beneficially owned and the sole
investment and voting power is held by the persons named.
  29
 
 Series D Preferred
Stock
 
 The
following table sets forth certain information, as of March 24, 2009, with
respect to holdings of our Series D Preferred Stock by (i) each person known by
us to be the beneficial owner of more than 5% of the total number of shares of
our Series D Preferred Stock outstanding as of such date, (ii) each of our
directors and  executive officers, and (iii) all directors and
executive officers as a group.  Except as otherwise indicated, the
address of each person is 707 Alexander Road, Suite 208, Princeton, New Jersey
08540.
   Nameof
      BeneficialOwner
              Amount
      andNature
      of BeneficialOwnership(1)
              Percent
                Of
                Class5% Beneficial
      Owners:Princeton
      Valuation Consultants, L.L.C.

                5
      Vaughn Drive
                Princeton,
      New Jersey 08540
              138,000
              20.0%Frederick
      C. Tecce

                c/o
      Mikros Systems Corporation
                707
      Alexander Road, Bldg 2,Suite
      208
                Princeton,
      New Jersey 08540
              138,000
              20.0%JoAnne
      E. Burns

                c/o
      Mikros Systems Corporation
                707
      Alexander Road, Bldg 2, Suite 208
                Princeton,
      New Jersey 08540
              69,000
              10.0%George W.
      Taylor

                c/o Mikros Systems
      Corporation
                707
      Alexander Road, Bldg 2, Suite 208
                Princeton, New
      Jersey 08540
              69,000
              10.0%Directors and
      Executive Officers:Walter
      T. Bristow
                220
      Commerce Drive, Suite 300
                Fort
      Washington, Pennsylvania 19034
              --
              --Paul
      G. Casner
              --
              --Patricia
      A. Kapp
              --
              --Thomas
      C. Lynch
              --
              --Thomas
      J. Meaney
              138,000
              20.0%Wayne
      E. Meyer
              138,000
              20.0%Tom
      L. Schaffnit
              --
              --Henry
      Silcock
              --
              --Marc
      Dalby
              --
              --All
      Current Directors and Officers as a Group (nine persons)
              276,000
              40.0%
 
 (1)
              Except
      as otherwise indicated, all shares are beneficially owned and the sole
      investment and voting power is held by the persons
  named.
 
 30
 
 EQUITY
COMPENSATION PLAN INFORMATION
 
 The
following is certain information about our equity compensation plans as of
December 31, 2008:
 
 (a)
              (b)
              (c)Number
      of securities
                to
      be issued upon
                exercise
      of outstanding
                options,
      warrants and rights
              Weighted
      –average
                exercise
      price of
                outstanding
      options,
                warrants
      and rights
              Number
      of securities
                remaining
      available for
                future
      issuance under
                equity
      compensation plans
                (excluding
      securities
                reflected
      in column (a)Plan
      CategoryEquity
      compensation plans approved by security holders
              361,818
              $0.1658
              0Equity
      compensation plans not approved by security holders
              420,000
              $0.55
              2,580,000Total
              791,000
              $0.38
              2,580,000
 
 2007 Stock Incentive
Plan
 
 On August
6, 2007, we adopted the Mikros Systems Corporation 2007 Stock Incentive Plan
(the "Plan").  Awards  may be made under the Plan for up to
3,000,000 shares of our common stock in the form of stock  options or
restricted stock awards.  Awards may be made to our employees,
officers or directors as well as our consultants or advisors.  The
Plan is administered by our Board of Directors which has full and final
authority to interpret the Plan, select the persons to whom awards may be
granted, and determine the amount, vesting and all other terms of any
awards.  To the extent permitted by applicable law, our Board may
delegate any or all of its powers under the Plan to one or more committees or subcommittees
of the Board.  The Plan is not subject to the provisions of the
Employee Retirement Income Security Act of 1974, as amended, and is not a
"qualified plan" under Section 401(a) of the Internal Revenue Code of 1986, as
amended.  The Plan has not been approved by our
shareholders.  As a result, "incentive stock options" as defined under
Section 422 of the Internal Revenue Code may not be granted under the Plan until
such approval is received for the Plan. The Plan terminates on August 5,
2017.
 
 All stock
options granted under the Plan are exercisable for a period of up to ten years
from the date of grant, are subject to vesting as determined by the Board upon
grant, and have an exercise price equal to not less than the fair market value
of our common stock on the date of grant.  Unless otherwise determined
by the Board, awards may not be transferred except by will or the laws of
descent and distribution.  The Board has discretion to determine the
effect on any award granted under the Plan of the death, disability, retirement,
resignation, termination  or other change in employment or other
status of any participant in the Plan.  The maximum number of shares
of common stock for which awards may be granted to a participant under the Plan
in any calendar year is 300,000.
  31
 
 Upon the
occurrence of a "reorganization event", defined as the merger of the Company
with or into another corporation as a result of which our common stock is
converted into or exchanged for cash, securities or other property or is
cancelled, the exchange of all shares of our common stock for cash, securities
or other property pursuant to a share exchange, or the liquidation of the
Company, the Board may take any number of actions.  These actions
include, providing for all options outstanding under the Plan to be assumed by
the acquiring corporation or to become immediately vested and exercisable in
full, and in the case of a reorganization event in which holders of our common
stock receive a cash payment, to provide for a cash payment to holders of
options equal to the excess, if any, of the per share cash payment over the
exercise price of such options.  As of the date of this report, we
have issued options under the Plan to purchase 420,000 shares of common
stock.
 
 ITEM
13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE.
 
 Certain
Relationships
 
 We pay
Wayne E. Meyer $1,500 per month for use of office space at Three Crystal Park,
2231 Crystal Drive, Suite 1005 in Arlington, Virginia.  Mr. Meyer is
the Chairman of the Board of Directors of the Company.
 
 Director
Independence
 
 Upon
consideration of the criteria and requirements regarding director independence
set forth in the rules of the National Association of Securities Dealers, Inc.
(“NASD”), our board of directors has determined that Paul G. Casner,
Thomas  C. Lynch, Tom L. Schaffnit (Chair) and Wayne E. Meyer, who
constitute a majority of its members, are independent.
 
 With
regard to our audit committee, the board of directors has determined that
Messrs. Casner, Lynch and Schaffnit are independent and that Mr. Meyer does not
satisfy the independence criteria for audit committee members set forth in NASD
Rule 4350(d) and Rule 10A-3(b)(1) of the Exchange Act.
 
 ITEM
14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES.
 
 Audit
Fees
 
 We have
engaged Beard Miller Company LLP for the audit of our financial statements for
the years ended December 31, 2008 and 2007 and the reviews of the financial
statements included in each of our quarterly reports on Form 10-Q during the
years ended December 31, 2008 and 2007 for a fee of $35,000 and $30,986,
respectively.
 
 Audit-Related
Fees
 
 There
were no fees billed by our independent accountants for audit-related services
during the fiscal years ended December 31, 2008 and 2007.
 
 Tax Fees
 
 There
were no fees billed by our independent accountants for tax fees for the years
ended December 31, 2008 and 2007.
  All Other
Fees
 
 There
were no fees billed by our independent accountants for non-audit services during
the years ended December 31, 2008 and 2007.
 
 Audit Committee Pre-Approval
Policies and Procedures
 
 All
auditing services and non-audit services (other than the de minimis exceptions
provided by Exchange Act) provided to us by our independent accountants must be
pre-approved by the Audit Committee. Any future Audit-Related Fees and Tax Fees
will be pre-approved by the Audit Committee.
  32
 
 ITEM
15.  EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
 
 The
following exhibits are filed as part of this report:
 
 3.1
              Certificate
      of Incorporation (incorporated by reference to Exhibit 2(I) to the
      Company's Registration Statement on Form S-18, File No. 2-67918-NY, as
      amended).3.2
              By-laws
      (incorporated by reference to Exhibit 2(II) to the Company's Registration
      Statement on Form S-18, File No. 2-67918-NY, as
  amended).3.3
              Form
      of Certificate of Amendment to Certificate of Incorporation (incorporated
      by reference to Exhibit 2(III) to the Company's Registration Statement on
      Form S-18, File No. 2-67918-NY, as amended).3.4
              Form
      of Certificate of Amendment of Incorporation with respect to increase of
      authorized shares (incorporated by reference to Exhibit 2(IV) to the
      Company's Registration Statement on Form S-18, File No. 2-67918-NY, as
      amended).3.5
              Certificate
      of Designations of Series B Preferred Stock and Series C Preferred Stock
      (incorporated by reference to Exhibit 4.1 to Form 8-K filed September 12,
      1988).3.6
              Certificate
      of Designations of Series D Preferred Stock (incorporated by reference to
      Exhibit 4.16 to Form 10-K for 1993 filed March 30,
  1994).10.1
              Mikros
      Systems Corporation 2007 Stock Incentive Plan (incorporated by reference
      to Exhibit 10.1 to Form 8-K filed August 9, 2007).14.1
              Mikros
      Systems Corporation Code of Business Conduct and Ethics (incorporated by
      reference to Exhibit 14 to Form 10-QSB filed August 11,
    2006).31.1
              Certification
      of principal executive officer and principal financial officer pursuant to
      Section 302 of the Sarbanes-Oxley  Act of
  2002.32.1
              Certification
      of principal executive officer and principal financial officer pursuant to
      Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C.
    1350.
  33
  SIGNATURES
 
 Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
  MIKROS SYSTEMS
      CORPORATIONDated:
      Dated: March 30, 2009
                By:
                /s/ Thomas
      J. MeaneyThomas
      J. Meaney
                  President
      and Chief Financial Officer
                  (Principal
      Accounting Officer)
  Pursuant
to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities indicated and on the date
indicated.
  SIGNATURES
                                
                                TITLE
                                
                                DATE/s/
      Wayne E. Meyer
                                
                                Chairman
                                
                                March
      30, 2009Wayne
      E. Meyer/s/
      Paul G. Casner
                                
                                Director
                                
                                March
      30, 2009Paul
      G. Casner/s/
      Thomas C. Lynch
                                
                                Director
                                
                                March
      30, 2009Thomas
      C. Lynch
 /s/
      Thomas J. Meaney
                                    
                                    Director
                                    
                                    March
      30, 2009Thomas
      J. Meaney/s/
      Tom L. Schaffnit
                                    
                                    Director
                                    
                                    March
      30, 2009Tom
      L. Schaffnit
 34
  Report
of Independent Registered Public Accounting Firm
 
 To the
Board of Directors and Shareholders of
 MIKROS
SYSTEMS CORPORATION
 
 We have
audited the accompanying balance sheets of Mikros Systems Corporation (the
Company) as of December  31, 2008 and 2007, and the related statements
of income, shareholders’ equity, and cash flows for the years then ended. These
financial statements are the responsibility of the Company’s
management.  Our responsibility is to express an opinion on these
financial statements based on our audits.
 
 We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting.  Our audits included consideration
of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting.  Accordingly, we express no such
opinion.  An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.  We
believe that our audits provide a reasonable basis for our opinion.
 
 In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of Mikros Systems Corporation as of
December 31, 2008 and 2007, and the results of its operations and its cash flows
for the years then ended in conformity with accounting principles generally
accepted in the United States of America.
  /s/
      Beard Miller Company LLPBeard
      Miller Company LLP
                    Malvern,
      Pennsylvania
                    March
      30, 2009
 35
  MIKROS
SYSTEMS CORPORATION
 BALANCE
SHEET
   DECEMBER
      31,
                2008
              
              
              DECEMBER
      31,
                2007CURRENT
      ASSETSCash
      and cash equivalents
              
              $
              608,530
              
              
              
              404,557Receivables
      on Government Contracts
              
              
              169,766
              
              
              
              303,469Other
      Current Assets
              
              
              17,903
              
              
              
              17,547TOTAL
      CURRENT ASSETS
              
              
              796,199
              
              
              
              725,573Patents
      and Trademarks
              
              
              5,383
              
              
              
              5,383Less:
      Accumulated Amortization
              
              
              (760
              )
              
              
              (422
              )4,623
              
              
              
              4,961PROPERTY
      AND EQUIPMENTEquipment
              
              
              14,625
              
              
              
              14,625Furniture
      & Fixtures
              
              
              9,264
              
              
              
              9,26423,889
              
              
              
              23.889Less:  Accumulated
      Depreciation
              
              
              (15,235
              )
              
              
              (10,786
              )8,654
              
              
              
              13,103Deferred
      Tax Assets
              
              
              18,000
              
              
              
              70,500TOTAL
      ASSETS
              
              $
              827,476
              
              
              $
              814,137LIABILITIES AND
      SHAREHOLDERS’  EQUITYCURRENT
      LIABILITIESAccrued
      Payroll and Payroll Taxes
              
              $
              98,193
              
              
              
              86,757Accounts
      Payable and Accrued Expenses
              
              
              143,654
              
              
              
              231,554TOTAL
      CURRENT LIABILITIES
              
              
              241,847
              
              
              
              318,311Long-term
      Liabilities
              
              
              11,170
              
              
              
              14,460TOTAL
      LIABILITIES
              
              
              253,017
              
              
              
              332,771REDEEMABLE
      SERIES C PREFERRED STOCKPar
      value $.01 per share, authorized 150,000 shares, issuedand
      outstanding 5,000 shares (involuntary liquidation value -
      $80,450)
              
              
              80,450
              
              
              
              80,450SHAREHOLDERS’
      EQUITYPreferred
      Stock, Series B convertible, par value $.01 per share,authorized
      1,200,000 shares, issued and outstanding 1,102,433shares
      (involuntary liquidation value - $1,102,433)
              
              
              11,024
              
              
              
              11,024Preferred
      Stock, convertible, par value $.01 per share, authorized2,000,000
      shares, issued and outstanding 255,000 shares (involuntaryliquidation
      value - $255,000)
              
              
              2,550
              
              
              
              2,550Preferred
      Stock, Series D, par value $.01 per share, 690,000 sharesauthorized,
      issued and outstanding (involuntary liquidation value-
      $1,518,000)
              
              
              6,900
              
              
              
              6,900Common
      Stock, par value $.01 per share, authorized 60,000,000
    shares,issued
      and outstanding 31,766,753 shares
              
              
              317,668
              
              
              
              317,668Capital
      in excess of par value
              
              
              11,468,662
              
              
              
              11,430,668Accumulated
      Deficit
              
              
              (11,312,795
              )
              
              
              (11,367,894
              )TOTAL
      SHAREHOLDERS’ EQUITY
              
              
              494,009
              
              
              
              400,916TOTAL
      LIABILITIES AND SHAREHOLDERS’ EQUITY
              
              $
              827,476
              
              
              $
              814,137
  See
Notes to Financial Statements
  36
  MIKROS
SYSTEMS CORPORATION
 STATEMENTS
OF INCOME
   Years
      Ended December 31,2008
              
              
              2007Contract
      Revenues
              
              $
              3,098,264
              
              
              $
              3,078,492Cost
      of sales
              
              
              1,628,388
              
              
              
              1,828,184Gross
      margin
              
              
              1,469,876
              
              
              
              1,250,308ExpensesEngineering
              
              
              578,105
              
              
              
              436,104General
      and Administrative
              
              
              761,428
              
              
              
              651,155Total
      expenses
              
              
              1,339,533
              
              
              
              1,087,259Income
      from operations
              
              
              130,343
              
              
              
              163,049Other
      Income:Interest
              
              
              3,017
              
              
              
              5,543Net
      income before income taxes
              
              
              133,360
              
              
              
              168,592Income
      tax expense
              
              
              78,261
              
              
              
              2,781Net
      income
              
              $
              55,099
              
              
              $
              165,811Basic
      and diluted earnings per share
              
              $
              0.00
              
              
              $
              0.00Weighted
      average number of shares outstanding
              
              
              31,766,753
              
              
              
              31,766,753
 See
Notes to Financial Statements
  37
 
 MIKROS
SYSTEMS CORPORATION
 STATEMENTS
OF SHAREHOLDERS’ EQUITY
 YEARS
ENDED DECEMBER 31, 2008 AND 2007
 Preferred
      Stock Series B
              
              
              Preferred
      Stock
              
              
              Preferred
      Stock Series D$0.01
      Par Value
              
              
              $0.01
      Par Value
              
              
              $0.01
      Par ValueNumber
              
              
              Par
              
              
              Number
              
              
              Par
              
              
              Number
              
              
              Parof
      shares
              
              
              Value
              
              
              of
      shares
              
              
              Value
              
              
              of
      shares
              
              
              ValueBalance,
      January 1, 2007
              
              
              1,102,433
              
              
              $
              11,024
              
              
              
              255,000
              
              
              $
              2,550
              
              
              
              690,000
              
              
              $
              6,900Net
      Income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Balance,
      December 31 ,2007
              
              
              1,102,433
              
              
              $
              11,024
              
              
              
              255,000
              
              
              $
              2,550
              
              
              
              690,000
              
              
              $
              6,900Stock
      Compensation – Options
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Net
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Balance,
      December 31, 2008
              
              
              1,102,433
              
              
              $
              11,024
              
              
              
              255,000
              
              
              $
              2,550
              
              
              
              690,000
              
              
              $
              6,900
  Capital
      inCommon
      Stock
                $0.01
      Par Value
              
              
              Excess
      of
                Par
      Value
              
              
              Accumulated
                Deficit
              
              
              TotalNumber
              
              
              Parof
      shares
              
              
              ValueBalance,
      January 1, 2007
              
              
              31,766,753
              
              
              $
              317,668
              
              
              $
              11,422,976
              
              
              $
              (11,533,705
              )
              
              $
              227,413Stock
      Compensation – Options
              
              
              
              
              
              
              
              
              
              
              7,692
              
              
              
              
              
              
              
              7,692Net
      Income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              165,811
              
              
              
              165,811Balance,
      December 31, 2007
              
              
              31,766,753
              
              
              $
              317,668
              
              
              $
              11,430,668
              
              
              $
              (11,367,894
              )
              
              $
              400,916Stock
      Compensation – Options
              
              
              -
              
              
              
              -
              
              
              
              37,994
              
              
              
              -
              
              
              
              37,994Net
      Income
              
              
              -
              
              
              
              -
              
              
              
              
              
              
              
              55,099
              
              
              
              55,099Balance,
      December 31, 2008
              
              
              31,766,753
              
              
              $
              317,668
              
              
              $
              11,468,662
              
              
              $
              (11,312,795
              )
              
              $
              494,009
 
 See
Notes to Financial Statements
  38
 
 MIKROS
SYSTEMS CORPORATION
 STATEMENTS
OF CASH FLOWS
 
 
 Years
      Ended December 312008
              
              
              2007Cash
      Flow From Operating Activities:Net
      income
              
              $
              55,099
              
              
              $
              165,811Adjustments
      to reconcile net incometo
      net cash provided by operating activities:Depreciation
      and Amortization
              
              
              4,787
              
              
              
              5,243Deferred
      Tax (Benefit) Expense
              
              
              52,500
              
              
              
              (22,500
              )Stock
      Compensation – Options
              
              
              37,994
              
              
              
              7,692Net
      Changes in Operating Assets and LiabilitiesDecrease
      (Increase) in Receivables on Government Contracts
              
              
              133,703
              
              
              
              (101,747
              )Increase
      in Other Current Assets
              
              
              (356
              )
              
              
              (1,747
              )(Decrease)
      Increase  in Accounts Payable and Accrued
    Expenses
              
              
              (87,901
              )
              
              
              123,045Increase
      in Accrued Payroll and Payroll Taxes
              
              
              11,436
              
              
              
              11,639Decrease
      in Long-term Liabilities
              
              
              (3,290
              )
              
              
              (1,563
              )Net
      Cash Provided By Operating Activities
              
              
              203,973
              
              
              
              185,873Cash
      Flow From Investing Activities:Purchase
      of Property and Equipment
              
              
              0.00
              
              
              
              (10,775
              )Net
      Cash Used In Investing Activities:
              
              
              0.00
              
              
              
              (10,775
              )Net
      Increase in cash and cash equivalents
              
              
              203,973
              
              
              
              175,098Cash
      and cash equivalents, beginning of year
              
              
              404,557
              
              
              
              229,459Cash
      and cash equivalents, end of year
              
              $
              608,530
              
              
              $
              404,557Supplementary
      Cash Flows Information:Income
      taxes paid
              
              $
              34,300
              
              
              $
              7,242
 
 See
Notes to Financial Statements
  39
  MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
 
 
 NOTE
1 - THE COMPANY
 
 Mikros
Systems Corporation (“Mikros”, “the Company”) is an advanced technology company
specializing in the research and development of electronic systems technology
primarily for military applications.  Classified by the U.S.
Department of Defense (DoD) as a small business, our capabilities include
technology management, electronic systems engineering and integration, radar
systems engineering, combat/command, control, communications, computers and
intelligence (C4I) systems engineering, and communications
engineering.
 
 The
Company’s primary business focus is to pursue Small Business Innovation Research
(SBIR) programs from the U.S. Department of Defense, Department of Homeland
Security, and other governmental authorities, and to expand this government
funded research and development into products, services, and business areas of
the Company.  Since 2002, the Company has been awarded a number of
Phase I, II, and III SBIR contracts.
  NOTE
2 - SIGNIFICANT ACCOUNTING POLICIES
 
 Cash and cash
equivalents
 
 Cash balances consist of
funds that are immediately available to the Company and are held by financial
institutions.  For purposes of the cash flow statements, the
Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.
 
 Fair value of financial
instruments
 
 The
carrying value of cash and cash equivalents, receivables on government
contracts, and accounts payable approximates fair value due to the current
maturity of these instruments.
 
 Concentrations of credit
risk
 
 Financial
instruments that subject the Company to credit risk consist of  cash
and cash equivalents and accounts receivable.
 
 The
Company's policy is to limit the amount of credit exposure to any one financial
institution, and place investments with financial institutions evaluated as
being creditworthy, or in short-term money market funds which are exposed to
minimal interest rate and credit risk. The Company maintains its cash primarily
in investment accounts within large financial institutions. The Federal Deposit
Insurance Corporation insures these balances up to $250,000 ($100,000 at
December 31, 2007) per bank. The Company has not experienced any losses on its
bank deposits and management believes these deposits do not expose the Company
to any significant credit risk.
 
 Receivables
on Government Contracts are stated at outstanding balances, less an allowance
for doubtful accounts, if necessary.  When necessary, the allowance
for doubtful accounts is established through provisions charged against
operations.  Receivables deemed to be uncollectible are charged
against the allowance and subsequent recoveries, if any, are credited to the
allowance.
  40
 MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
 The
allowance for doubtful accounts is maintained at a level considered adequate to
provide for losses that can be reasonably anticipated. Management’s periodic
evaluation of the adequacy of the allowance is based on past experience, agings
of the receivables, adverse situations that may affect a customers’ ability to
pay, current economic conditions and other relevant factors.  This
evaluation is inherently subjective as it requires estimates that may be
susceptible to significant change.  Unpaid balances remaining after
the stated payment terms are considered past due.  No allowance for
doubtful accounts was deemed necessary by management at December 31, 2008 and
2007.
 
 Property and
Equipment
 
 Equipment
is stated at cost. Depreciation is computed using the straight-line method based
on estimated useful lives of 3 years. Depreciation expense amounted to $3,125
and $4,050 for years ended December 31, 2008 and 2007,
respectively.
 
 Furniture
and Fixtures are  stated at cost.  Depreciation expense is
computed using the straight-line method based on estimated useful lives of 7
years.  Depreciation expense amounted to $1,324 and $854 for the years
ended December 31, 2008 and 2007.
 
 Patents and
Trademarks
 
 The
Company holds two patents covering digital signal processing technology and its
base scheme of implementing Link-11.  The Company has also developed
and continues to develop intellectual property (technology and data) under its
SBIR contracts.  The request for a trademark for the product name
“ADEPT” has been approved by the U.S. Patent and Trademark Office, and ADEPT® is
now a registered trademark of the Company.
 
 Under
SBIR data rights, the Company is protected from unauthorized use of
SBIR-developed technology and data for a period of five years after acceptance
of all items to be delivered under a particular SBIR contract or any follow-on
contract.
 
 For each
of the years ended December 31, 2008 and 2007, amortization expense amounted to
$338 related to the cost of the patents and trademarks. These costs are being
amortized over their 10 year legal lives.
 
 Impairment of long-lived
assets
 
 The
Company assesses the potential impairment of long-lived assets whenever events
or changes in circumstances indicate that the carrying value may not be
recoverable. An asset's value is impaired if management's estimate of the
aggregate future cash flows, undiscounted and without interest charges, to be
generated by the asset are less than the carrying value of the asset. Such cash
flows consider factors such as expected future operating income and historical
trends, as well as the effects of demand and competition. To the extent
impairment has occurred, the loss is measured as the excess of the carrying
amount of the asset over the estimated fair value of the asset. Such estimates
require the use of judgment and numerous subjective assumptions, which, if
actual experience varies, could result in material differences in the
requirements for impairment charges. There were no impairments of long-lived
assets in 2008 or 2007.
  41
 MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
 Stock
Options
 
 Effective
January 1, 2006, we adopted the fair value recognition provisions of FASB
Statement No. 123(R), “Share Based Payment,” using the modified-prospective
transition method.  Under that transition method, compensation cost
recognized after January 1, 2006 includes: (a) compensation cost for all
share-based payments granted prior to, but not yet vested, as of January 1, 2006
based on the grant-date fair value calculated in accordance with the provision
of Statement No. 123(R), and (b) compensation cost for all share-based payments
granted subsequent to December 31, 2005, based on the grant-date fair value
calculated in accordance with the provision of Statement 123(R).  We
had no unvested stock options at December 31, 2005, therefore, the adoption of
Statement 123(R) relates only to share-based payments granted after January 1,
2006.
 
 In
accordance with the recognition provisions of SFAS No. 123(R), the Company
recognized stock-based compensation expense of $37,994 and $7,692 for the years
ended December 31, 2008 and 2007 which is included in general and administrative
expenses in the accompanying financial statements.  The fair value of
each option grant is estimated on the date of grant using the Black-Scholes
option pricing model with the following weighted average assumptions:
  2008
 3  year
      options
              5
      year optionsExpected
      Life
              7.50
              5Expected
      volatility
              122%
              122%Risk-free
      interest rate
              2.71%
              2.71%
  2007
 3  year
      options
              5
      year optionsExpected
      Life
              3
              5Expected
      volatility
              80%
              95%Risk-free
      interest rate
              4.07%
              4.44%
 
 The
expected life of options granted is based on the vesting period.  The
expected volatility is based on historical stock prices.  The
risk-free interest rate is determined using the U.S. Treasury bill rate at the
time of grant.  The Company has never paid a dividend, and as such the
dividend yield is zero.
 
 Revenue
Recognition
 
 The
Company is engaged in research and development contracts with the Federal
Government to develop certain technology to be utilized by the US Department of
Defense. The contracts are cost plus fixed fee contracts and the Company
accounts for these contracts within the scope of Chapter 11 of Accounting
Research Bulletin No. 43, Government Contracts or Statement of Position 81-1,
Accounting for Performance of Construction-Type and Certain Production-Type
Contracts using the percentage-of -completion accounting method. Under this
method, revenue is recognized based on the extent of progress towards completion
of the long term contract.
 
 The
Company generally uses a variation of the cost to cost method to measure
progress for all long term contracts unless it believes another method more
clearly measures progress towards completion of the contract.
 
 Revenues
are recognized as costs are incurred and include estimated earned fees, or
profit, calculated on the basis of the relationship between costs incurred and
total estimated costs at completion.
 
 Unbilled
revenue reflects work performed, but not billed at the time, per contractual
requirements. As of December 31 2008 and 2007, the Company had $0 of
unbilled revenues.  Billings to customers in excess of revenue earned
are classified as advanced billings, and shown as a liability.  As
of December 31, 2008and 2007, the Company had no advanced
billings.
  42
 MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
 Income
Taxes
 
 The
Company accounts for income taxes under the liability method prescribed by SFAS
No. 109, Accounting for Income
Taxes.  Deferred tax assets and liabilities are determined
based on the difference between the financial statement and the tax bases of
assets and liabilities as measured by the enacted tax rates that are expected to
be in effect when these differences reverse.  Deferred tax expense
(benefit) is the result of changes in deferred tax assets and
liabilities.  Deferred tax assets are reduced by a valuation allowance
when, in the opinion of management, it is more likely than not that some portion
of a deferred tax asset will not be realized.
 
 The
Company adopted the provisions of Financial Accounting Standards Board (FASB)
Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, on January 1, 2007. FIN 48 prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. As
a result of the Company’s evaluation of the provisions of FIN 48, no
significant income tax uncertainties were identified.  Therefore the
Company recognized no adjustment for unrecognized tax benefits for the years
ended December 31, 2008 and 2007.
 
 The
Company has determined that any future interest accrued, related to unrecognized
tax benefits, will be included in interest expense. In the event the Company
must accrue for penalties as a result of FIN 48, they will be included as
an operating expense.
 
 Earnings per
share
 
 The
Company has adopted the provisions of SFAS 128, Earnings per Share. Basic
earnings per share is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding during
the period. SFAS 128 also requires a dual presentation of basic and diluted
earnings per share on the face of the statement of income for all companies with
complex capital structures.
 
 Diluted
earnings per share reflects the amount of earnings for the period available to
each share of common stock outstanding during the reporting period, while giving
effect to all dilutive potential common shares that were outstanding during the
period, such as common share equivalents that could result from the potential
exercise into common stock. The computation of diluted earnings per share does
not assume exercise of securities that would have an anti-dilutive effect on per
share amounts (i.e.,
increasing earnings per share or reducing loss per share). The dilutive effect
of outstanding options are reflected in dilutive earnings per share by the
application of the treasury stock method which recognizes the use of proceeds
that could be obtained upon the exercise of options in computing diluted
earnings per share. It assumes that any proceeds would be used to purchase
common stock at the average market price during the period. Options will have a
dilutive effect only when the average market price of the common stock during
the period exceeds the exercise price of the options.
  Use of
Estimates
 
 The
preparation of Financial Statements in conformity with accounting principles
generally accepted in the United States (“GAAP”) requires Company management to
make estimates and assumptions that affect the amounts reported in the Financial
Statements contained herein and accompanying notes to the Financial Statements.
The most significant estimates relate to revenue recognition, allowance for
doubtful accounts, stock-based compensation expense, and impairment
of  long-lived assets. Actual results could differ from those
estimates.
  43
 MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
 Recently Issued Accounting
Standards
  In
November 2008, the SEC released a proposed roadmap regarding the potential use
by U.S. issuers of financial statements prepared in accordance with
International Financial Reporting Standards (IFRS).  IFRS is a
comprehensive series of accounting standards published by the International
Accounting Standards Board (“LASB”). Under the proposed roadmap, the Company may
be required to prepare financial statements in accordance with IFRS as early as
2014.  The SEC will make a determination in 2011 regarding the
mandatory adoption of IFRS.  The Company is currently assessing the
impact that this potential change would have on its financial statements, and it
will continue to monitor the development of the potential implementation of
IFRS.
  In June
2008, the Emerging Issues Task Force (“EITF”) ratified Issue No. 07-5,
“Determining Whether an Instrument (or Embedded Feature) Is Indexed to an
Entity’s Own Stock” (“EITF 07-5”).  EITF 07-5 clarifies how to
determine whether certain instruments or features were indexed to an entity’s
own stock.   The consensus will replace EITF 01-6 as a critical
component of the literature applied to evaluating financial instruments for debt
or equity classification and embedded features for bifurcation as
derivatives.  EITF 07-5 will become effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years.  The Company is currently analyzing the
impact on the Company’s Financial Statements.
  In
May 2008, the FASB issued Statement No. 162, “The Hierarchy of
Generally Accepted Accounting Principles” (“SFAS No. 162”).  SFAS No. 162
identifies the sources for GAAP and lists the categories in descending
order.  An entity should follow the highest category of GAAP applicable for
each of its accounting transactions.  SFAS No. 162 is effective 60 days
following the SEC’s approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles.” The adoption of SFAS No. 162 will not
have a material effect on the Company’s financial statements.
 
 In
February 2007, the FASB issued SFAS No. 159, “Fair Value Option for Financial
Assets and Liabilities” (“SFAS No. 159”).  SFAS No. 159 allows
companies to choose, at specific election dates, to measure eligible financial
assets and liabilities that are not otherwise required to be measured at fair
value, at fair value.  Under SFAS No. 159, companies would report
unrealized gains and losses for which the fair value option has been elected in
earnings at each subsequent reporting date, and recognize up-front costs and
fees related to those items in earnings as incurred.  SFAS No. 159
became effective for fiscal years beginning after November 15,
2007.  The Company adopted SFAS No. 159 during 2008 and elected to not
measure any financial assets or liabilities at fair value.
 
 In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
No. 157”).  SFAS No. 157 establishes a common definition for fair
value to be applied to U.S. GAAP requiring use of fair value, establishes a
framework for measuring fair value, and expands disclosure about such fair value
measurements. SFAS No. 157 is effective for financial assets and financial
liabilities for fiscal years beginning after November 15, 2007. Issued in
February 2008, FSP 157-1 “Application of FASB Statement No. 157 to FASB
Statement No. 13 and Other Accounting Pronouncements That Address Fair Value
Measurements for Purposes of Lease Classification or Measurement under Statement
13” removed leasing transactions accounted for under Statement 13 and related
guidance from the scope of SFAS No. 157. FSP 157-2 “Partial Deferral of the
Effective Date of Statement 157” (“FSP 157-2”), deferred the effective date of
SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities to fiscal
years beginning after November 15, 2008.  FSP 157-3 “Determining the
Fair Value of a Financial Asset When the Market for That Asset Is Not Active”
(“FSP 157-3”) was released in October 2008 and was effective upon issuance. FSP
157-3 clarifies the application of SFAS 157 in a market that is not
active.  The implementation of SFAS No. 157 for financial assets and
financial liabilities, effective January 1, 2008, did not have a material impact
on the Company’s financial statements. The Company does not expect the adoption
of SFAS No. 157 for nonfinancial assets and nonfinancial liabilities to have a
material impact on its financial statements.
  44
 MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
 In
November 2007, the EITF reached a consensus on EITF 07-1: “Accounting for
Collaborative Arrangements” (“EITF 07-1”).   EITF No. 07-01
provides guidance for whether an arrangement constitutes a collaborative
arrangement, how costs incurred and revenue generated on sales to third parties
should be reported by the partners to a collaborative arrangement in each of
their respective income statements, how payments made to or received by a
partner pursuant to a collaborative arrangement should be presented in the
income statement, and what participants should disclose in the notes to the
financial statements about a collaborative arrangement. EITF 07-1 is
effective for annual periods beginning after December 15, 2008. Entities
are required to report the effects of applying EITF 07-1 as a change in
accounting principle through retrospective application to all periods to the
extent practicable. Upon application of EITF 07-1, the following is
required to be disclosed: a) a description of the prior-period information
that has been retrospectively adjusted, if any, and b) the effect of the
change on revenue and operating expenses (or other appropriate captions of
changes in the applicable net assets or performance indicator) and on any other
affected financial statement line item. The Company does not expect the adoption
of EITF 07-1 to have a material impact on its financial position, results
of operations and cash flows.
  In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (“SFAS No. 141(R)”).  SFAS No. 141(R) significantly
changes the accounting for business combinations. Under SFAS No. 141(R), an
acquiring entity will be required to recognize all the assets acquired and
liabilities assumed in a transaction at the acquisition-date at fair value with
limited exceptions.  SFAS No. 141(R) further changes the accounting
treatment for certain specific items, including:
  §
              Acquisition
      costs will be generally expensed as
incurred;
  §
              Noncontrolling
      interests (formerly known as “minority interests”) will be recorded at
      fair value at the acquisition date;
  §
              Acquired
      contingent liabilities will be recorded at fair value at the acquisition
      date and subsequently measured at either the higher of such amount or the
      amount determined under existing guidance for non-acquired
      contingencies;
  §
              In-process
      research and development (IPR&D) will be recorded at fair value as an
      indefinite-lived intangible asset at the acquisition
  date;
  §
              Restructuring
      costs associated with a business combination will be generally expensed
      subsequent to the acquisition date;
and
  §
              Changes
      in deferred tax asset valuation allowances and income tax uncertainties
      after the acquisition date generally will affect income tax
      expense.
  SFAS No.
141(R) includes a substantial number of new disclosure requirements. SFAS No.
141(R) applies prospectively to business combinations for which the acquisition
date is on or after January 1, 2009.
 
 In March
2007 the EITF reached a consensus on EITF 07-3: “Accounting for Nonrefundable
Advance Payments for Goods or Services Received for Use in Future Research and
Development Activities” (“EITF 07-03”).  EITF 07-3 guidance states
that nonrefundable advance payments for goods or services that will be used or
rendered for future research and development activities should be deferred and
capitalized. Such amounts are required to be recognized as an expense as the
related goods are delivered or the related services are performed. Entities
should continue to evaluate whether they expect the goods to be delivered or
services to be rendered. If an entity does not expect the goods to be delivered
or services to be rendered, the capitalized advance payment should be charged to
expense.  EITF 07-1 became effective as of January 1, 2008 and
applies prospectively for new contracts. The adoption of EITF 07-3 did not have
a material impact on the Company’s consolidated financial
statements.
  45
 MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
 NOTE
3 – REDEEMABLE SERIES C PREFERRED STOCK AND SHAREHOLDERS’ EQUITY
 
 Redeemable Series C
Preferred Stock
 
 The
Redeemable Series C Preferred Stock is not convertible into any other class of
the Company’s stock and is subject to redemption at the Company’s option at any
time if certain events occur, such as capital reorganizations, consolidations,
mergers, or sale of all or substantially all of the Company’s
assets.  Each share is entitled to cast one vote on all matters to be
voted on by the Company’s shareholders.  Upon any liquidation,
dissolution or winding up of the Company, each holder of Redeemable Series C
Preferred Stock will be entitled to be paid, before any distribution or payment
is made upon any other class of stock of the Company, an amount in cash equal to
the redemption price for each share of Redeemable Series C Preferred Stock held
by such holder, and the holders of Redeemable Series C Preferred Stock will not
be entitled to any further payment. The redemption price is $16.09 per
share.
 
 Series B Convertible
Preferred Stock
 
 Each
share of Series B Preferred Stock is convertible into three shares of the
Company’s common stock at a price of $.33 per common share to be received upon
conversion and entitles the holder thereof to cast three votes on all matters to
be voted on by the Company’s shareholders.  Upon any liquidation,
dissolution, or winding up of the Company, each holder of Series B Preferred
Stock will be entitled to be paid, after all distributions of payments are made
upon redemption of the Series C Preferred Stock an amount in cash equal to $1.00
for each share of Series B Preferred Stock held, and such holders will not be
entitled to any further payment.
 
 Convertible Preferred
Stock
 
 Each
share of the convertible preferred stock can be redeemed at the Company’s option
for $1.00 per share or can be converted into one share of the Company’s common
stock and entitles the holder thereof to cast one vote on all matters to be
voted on by the Company’s shareholders.  This conversion rate is
subject to adjustment in certain circumstances.  Upon any liquidation,
dissolution or winding up of the Company, each holder will be entitled to their
redemption price once shareholders of Redeemable Series C Preferred Stock and
Series B Preferred stock have been fully paid.
 
 Series D Preferred
Stock
 
 The
Series D Preferred Stock provided for an annual cumulative dividend of $.10 per
share and entitles the holder thereof to cast one vote on all matters to be
voted on by the Company’s shareholders.  The shares are not
convertible into any other class of stock and are subject to redemption at the
Company’s option at any time at a redemption price of $1.00 per share plus all
unpaid cumulative dividends.  Upon liquidation, dissolution or winding
up of the Corporation, each holder of Series D Preferred Stock will be entitled
to be paid, after all distributions or payments are made upon the Corporation’s
Convertible Preferred Stock, Series B Preferred Stock, and Redeemable Series C
Preferred Stock, an amount in cash equal to the Redemption Price, as
defined,  for each share of Series D Preferred Stock held by such
holder. The holders of Series D Preferred Stock will not be entitled to any
further payment.
 
 Effective
January 1, 2006, the holders of the shares of Series D Preferred Stock agreed to
waive the future accumulation of dividends.  As of December 31, 2005,
there were dividends in arrears on the Series D Preferred Stock which were
accrued by the Company.  Such waiver does not affect dividends accrued
through December 31, 2005.  Accordingly, the accrued dividends in
arrears of $828,000 remain outstanding at December 31, 2008.
  46
 MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
 NOTE
4 - INCOME TAXES
 
 The
income tax provision is comprised of the following:
 
 2008
              
              
              2007Current
      state tax expense
              
              $
              25,761
              
              
              $
              25,281Deferred
      federal tax expense (benefit)
              
              
              52,500
              
              
              
              (22,500
              )Income
      Tax Expense
              
              $
              78,261
              
              
              $
              2,781
 
 The
reconciliation between the statutory federal income tax rate and the Company’s
effective tax rate is as follows:
  2008
              
              
              2007Federal
      statutory rate
              
              
              34.0
              %
              
              
              34.0
              %State
      taxes
              
              
              12.9
              
              
              
              10.1Permanent
      Differences
              
              
              14.4
              
              
              
              9.1Utilization
      of net operatingloss
      carry forwards andReduction
      of deferred tax assetvaluation
      allowance
              
              
              (2.6
              )
              
              
              (51.6
              )Effective
      tax rate
              
              
              58.7.
              %
              
              
              1.6
              %
  Total
available net operating loss carry forwards at December 31, 2008 are reflected
in the following schedule:
 
 Year
              
              Available
      ForOf
              
              FederalExpiration
              
              Tax
      Purposes2010
              
              $
              30,0002011
              
              
              1,422,0002012
              
              
              339,0002019
              
              
              307,0002021
              
              
              77,0002022
              
              
              39,0002023
              
              
              107,000$
              2,321,000
 
 During
2008, federal net operating loss carry forwards of approximately $206,000 were
utilized by the Company for purposes of the Company’s tax provision. The
Company’s valuation allowance associated with the related deferred tax assets
was reduced by approximately $1,000 and $79,000 in 2008 and 2007, respectively,
based on the Company’s anticipated profitability on existing contracts in the
near term.
  47
 MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
 Deferred
tax assets consist of the following as of December 31:
 
 2008
              
              
              2007Deferred
      tax asset:Fixed
      Assets & Other
              
              $
              32,000
              
              
              $
              15,306Net
      operating lossCarry
      forwards
              
              
              789,000
              
              
              
              859,165Valuation
      allowance
              
              
              (803,000
              )
              
              
              (803,971
              )Net
      deferred tax asset
              
              $
              18,000
              
              
              $
              70,500
  NOTE
5 - STOCK OPTIONS
 
 Incentive Stock Option
Plan
 
 The
Company has outstanding stock options for the purchase of the Company’s common
stock.  These options were issued pursuant to an Incentive Stock
Option Plan adopted by the Company in 1992. The ability to grant options under
this plan expired in 2002.  Specific terms of the remaining options
outstanding under this plan are set forth in individual stock option
agreements.  Generally, the exercise price of the options is the
market price of the Company’s stock on the date that the option was
granted.
 
 A summary
of the status of the Company’s Incentive Stock Option Plan as of December 31,
2008 and 2007 is presented below:
 
 Weighted
              
              
              
              
              
              
              
              
              WeightedWeighted
              
              
              Average
              
              
              
              
              
              Weighted
              
              
              AverageAverage
              
              
              Remaining
              
              
              
              
              
              Average
              
              
              RemainingExercise
              
              
              Contractual
              
              
              
              
              
              Exercise
              
              
              ContractualCommon
      Stock Options:
              
              2008
              
              
              Price
              
              
              Life
      (Years)
              
              
              2007
              
              
              Price
              
              
              Life
      (Years)Options
      outstanding beginning of year
              
              
              361,818
              
              
              $
              0.1658
              
              
              
              1.16
              
              
              
              361,818
              
              
              $
              0.1658
              
              
              
              2.16Granted
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Exercised
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Cancelled
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Options
      outstanding end of year
              
              
              361,818
              
              
              $
              0.1658
              
              
              
              -
              
              
              
              361,818
              
              
              $
              0.1658
              
              
              
              -Options
      exercisable, end of year:
              
              
              361,818
              
              
              
              0.1658
              
              
              
              -
              
              
              
              361,818
              
              
              
              0.1658
              
              
              
              -
 
 The
aggregate intrinsic value of options outstanding and exercisable under the
Incentive Stock Option Plan at December 31, 2008 and 2007 was approximately
$18,100 and $150,000.
  48
 MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
 The
aggregate intrinsic value of stock options above represents the total pre-tax
intrinsic value (the amount by which the current market value of the underlying
stock exceeds the exercise price of the options) that would have been received
by the option holders had they exercised their options on December 31, 2008 and
2007.  The aggregate intrinsic value of stock options changes based on
the changes in the market value of the Company’s common stock.
 
 2007 Incentive Stock Option
Plan
 
 On
October 3, 2007, the Company issued stock options to each member of its board of
directors, key employees and consultants under the Company’s 2007 Stock
Incentive Plan.  Directors of the Company were granted options to
purchase a total of 125,000 shares of the Company’s common stock, which vest
over a three-year period.  Key employees of the Company were granted
options to purchase a total of 305,000 shares of the Company’s common stock
which vest over a five-year period.  All of the options are
exercisable at $.55 per share, the last sales price of the Company’s common
stock as reported on the OTCBB on the date of grant.    In
2008, the Company granted to an employee of the Company, options to purchase
10,000 shares of the Company’s common stock which vest over a five year
period.  The options are exercisable at $.62 per share.  All
of the options have a term of 10 years and vest in equal annual installments
over a three or five year period.
 
 Weighted
              
              
              
              
              
              
              
              
              WeightedWeighted
              
              
              Average
              
              
              
              
              
              Weighted
              
              
              AverageAverage
              
              
              Remaining
              
              
              
              
              
              Average
              
              
              RemainingExercise
              
              
              Contractual
              
              
              
              
              
              Exercise
              
              
              ContractualCommon
      Stock Options:
              
              2008
              
              
              Price
              
              
              Life
      (Years)
              
              
              2007
              
              
              Price
              
              
              Life
      (Years)Options
      outstanding beginning of year
              
              
              430,000
              
              
              $
              0.55
              
              
              
              8.75
              
              
              
              430,000
              
              
              $
              0.55
              
              
              
              9.75Granted
              
              
              10,000
              
              
              
              0.62
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Exercised
              
              
              
              
              
              
              
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Forfeited
              
              
              20,000
              
              
              
              0.55
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Options
      outstanding end of year
              
              
              420,000
              
              
              $
              0.55
              
              
              
              8.75
              
              
              
              430,000
              
              
              $
              0.55
              
              
              
              9.75Weighted-average
      fair value of optionsgranted
      during the year
              
              
              -
              
              
              $
              0.30
              
              
              
              -
              
              
              
              -
              
              
              $
              0.30
              
              
              
              -
 
 As of
December 31, 2008, there were 98,666 options
exercisable.   At December 31, 2007 there were no options
exercisable.
 
 The
aggregate intrinsic value of options outstanding at December 31, 2008 and 2007
under the 2007 Stock Incentive Plan was $0 and $12,900.
 
 The
aggregate intrinsic value of stock options above represents the total pre-tax
intrinsic value (the amount by which the current market value of the underlying
stock exceeds the exercise price of the options) that would have been received
by the option holders had they exercised their options on December 31,
2008.  The aggregate intrinsic value of stock options changes based on
the changes in the market value of the Company’s common stock.  The
fair value (present value of the estimated future benefit to the option holder)
of each option grant is estimated on the date of the grant using the
Black-Scholes option pricing model.
 
 There
were a total of 321,334 unvested options at December 31, 2008, with a fair value
of approximately $121,600.  As of December 31, 2008, there was
approximately $113,000 of unamortized stock option compensation
expense.
  49
 MIKROS
SYSTEMS CORPORATION
 NOTES
TO FINANCIAL STATEMENTS
   NOTE
6 – EARNINGS PER SHARE
 
 The
Company’s calculation of earnings per share is as follows:
 
 2008
              
              
              2007Net
      income applicable to common shareholders
              
              $
              55,099
              
              
              $
              165,811Weighted
      average basic shares outstanding
              
              
              31,766,753
              
              
              
              31,766,753Assumed
      conversion of preferred stock
              
              
              3,562,299
              
              
              
              3,562,299Dilutive
      effect of options
              
              
              144,484
              
              
              
              170,182Weighted
      average dilutive shares outstanding
              
              
              35,473,536
              
              
              
              35,499,234Earnings
      per share – basic and diluted
              
              $
              0.00
              
              
              $
              0.00
 
 At
December 31, 2008 and 2007, there were 420,000 and 430,000 shares issuable upon
exercise of options which were excluded from the computation of dilutive
earnings per share due to their anti-dilutive effect.
 
 NOTE
7 – COMMITMENTS
 
 In
September 2005, Company executed a lease for engineering office space located in
Fort Washington, Pennsylvania that continues for 63 months.  The terms
of the lease include an annual rate increase through the end of the
lease.
 
 Total
rent expense during 2008 and 2007 was $62,912 and $62,237,
respectively.    The Company’s obligation under non
cancellable operating leases is as follow:
 
 2009
              
              $
              67,9292010
              
              $
              63,755TOTAL
              
              $
              131,684
 
 NOTE
8 – RELATED PARTY TRANSACTIONS
 
 During
2008 and 2007, the Company paid rent of $18,000 and $14,000 to a corporation
owned by one of the Company's directors for a location in which the Company
operates.
  NOTE
9 – SUBSEQUENT EVENTS
 
 In
February 2009, the Company executed a lease for a facility in Florida in which
the Company will support production of our Advanced Diagnostic Electronic
Portable Testset (ADEPT) product line including quality assurance, field
support, and life cycle management.  The lease agreement runs through
February  2010 for a total cost of $8,161.56.
 
 On
January 9, 2009, the Company entered  into a $50,000  line
of credit agreement with Sun National Bank (“Sun”).  The line of
credit will be available to the Company for one year.  The line of
credit is secured by a $50,000 Certificate of Deposit with Sun.
   50