The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

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.

Substantially all of the Company’s revenue is derived from SBIR and IDIQ contracts for the Federal government. Approximately 96% and 78% of revenues in 2012 and 2011, respectively, were realized in connection with task orders issued under the IDIQ contract with the Naval Surface Warfare Center to deliver ADEPT units. Although the Company’s operations are not subject to any particular government approval or regulations, the Company is dependent upon funding being made available to the DoD in amounts sufficient to cover the SBIR grants and other DoD contracts for which the Company competes.

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 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. 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. All of our business is conducted with the Federal government in which nonpayment for awarded contracts is unlikely. No allowance for doubtful accounts was deemed necessary by management at December 31, 2012 and 2011, respectively.

Equipment is stated at cost. Depreciation is computed using the straight-line method based on estimated useful lives of three years. Depreciation expense amounted to $5,548 and $6,908 for the years ended December 31, 2012 and 2011, respectively, and is included in engineering expense.

Furniture and Fixtures are stated at cost. Depreciation expense is computed using the straight-line method based on estimated useful lives of seven years. Depreciation expense amounted to $1,323 for each of the years ended December 31, 2012 and 2011, and is included in engineering expense.

The Company has developed and continues to develop intellectual property (technology and data) under SBIR and other 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.

During the year ended December 31, 2012, the Company discontinued the use of certain technology and related patents. The Company removed the historical carrying value of these patents of $4,000 from its balance sheet as of December 31, 2012 and immediately recognized $2,933 of unamortized balance as amortization expense for the year ended December 31, 2012.

For each of the years ended December 31, 2012 and 2011, amortization expense amounted to $3,122 and $338, respectively, which related to the cost of the patents and trademarks. These costs are being amortized over their 10 year legal lives. Amortization expense for 2013 through 2015 will be $138 per year and $71 in 2016.

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 2012 or 2011.

The Company is a party to 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 revenue is recognized based on the extent of progress towards completion of the long term 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. Under the terms of certain contracts, fixed fees are not recognized until the receipt of full payment has become unconditional, that is, when the product has been delivered and accepted by the Federal government. Backlog represents the estimated amount of future revenues to be recognized under negotiated contracts as work is performed. The Company’s backlog includes future ADEPT units to be developed and delivered to the Federal government. The estimated value of ADEPT and SBIR program backlog was $957,494 as of December 31, 2012.

Unbilled revenue reflects work performed, but not billed at the time, per contractual requirements. As of December 31, 2012 and 2011, the Company had no unbilled revenues. Billings to customers in excess of revenue earned are classified as advanced billings, and shown as a liability. As of December 31, 2012 and 2011, the Company had no advanced billings. Under the Indefinite-Delivery, Indefinite-Quantity (“IDIQ”) agreement, the Company delivered 36 units during the year ended December 31, 2012. As of December 31, 2012, the Company had an additional 17 units to be delivered under the IDIQ that are expected to be delivered in 2013. The 17 units are a component of the Company’s backlog as of December 31, 2012.

The Company provides a limited warranty, as defined by the related warranty agreements, for its production units. The Company’s warranties require the Company to repair or replace defective products during such warranty period, which is 12 months following delivery and acceptance of production units by the government. The Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company’s warranty liability include the number of units sold, expected and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amount as necessary. The Company incurred warranty expenses, which is a component of the Company’s cost of sales of $(7,900) and $36,400 for the years ended December 31, 2012 and 2011, respectively. Since the inception of the IDIQ contract in March 2010, the Company has delivered 99 ADEPT units. As of December 31, 2012, there are 54 ADEPT units that remain under the limited warranty coverage. The Company had an accrued warranty expense of $69,655 and $86,400 for the years ended December 31, 2012 and 2011, respectively.

Research and Development expenditures for research and development of the Company's products are expensed when incurred, and are included in general and administrative expenses. The Company recognized research and development costs of $59,245 and $43,519 for the years ended December 31, 2012 and 2011, respectively.

The Company records compensation expense associated with stock options and other forms of equity compensation based on the estimated fair value at the grant-date. There was no equity compensation awards issued for the year ended December 31, 2012. The Company uses the Black-Scholes-Merton (“BSM”) option-pricing model to determine the fair value of share-based awards. Expected volatility is based on historical volatility of the Company's common stock. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant.

The expected term is estimated consistent with the simplified method, as identified in ASC 718. In December 2007, the Securities and Exchange Commission (“SEC”) issued guidance that allows companies, in certain circumstances, to utilize a simplified method in determining the expected term of stock option grants when calculating the compensation expense to be recorded under GAAP, for employee stock options. The simplified method can be used after December 31, 2007 only if a company's stock option exercise experience does not provide a reasonable basis upon which to estimate the expected option term. Through 2007, the Company used the simplified method to determine the expected option term, based upon the vesting and original contractual terms of the option. The Company has continued to use the simplified method to determine the expected option term since the Company’s stock option exercise experience does not provide a reasonable basis upon which to estimate the expected option term.

The Company accounts for income taxes under a liability method. 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. Deferred tax assets, including tax loss and credit carryforwards, and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The deferred tax assets will 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.

The Company adopted 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. No significant income tax uncertainties were identified. Therefore, the Company recognized no adjustment for unrecognized tax benefits for the years ended December 31, 2012 and 2011.

Basic earnings per share ("EPS") is calculated by dividing net earnings allocable to common shareholders by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the assumed exercise or conversion of all dilutive securities, using the treasury stock method for options and if-converted method for convertible preferred securities. Potentially dilutive securities include employee stock options, Series B Preferred Stock, and Convertible Preferred Stock (see “Note 3. Redeemable Series C Preferred Stock and Shareholders’ Equity" below for information about the Series B Preferred Stock and Convertible Preferred Stock).

In June 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position ("FSP") Emerging Issues Task Force ("EITF") 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities" (ASC 260-10-45). ASC 260-10-45 clarified that all outstanding unvested share-based payment awards that contain rights to non-forfeitable dividends participate in undistributed earnings with common shareholders. Shares of the Company's Convertible Preferred Stock are considered participating securities since they contain a non-forfeitable right to dividends and distributions with common shareholders. ASC 260-10-45 requires that the two-class method of computing basic EPS be applied. Under the two-class method, the Company's stock options are not considered to be participating securities. Dividends on common stock were not declared in 2012 or 2011. ASC 260-10-45 is effective for fiscal years beginning after December 15, 2008 and was adopted by the Company during the first quarter of 2009. There was no impact of significance on basic or diluted EPS as a result of the adoption of ASC 260-10-45.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards (ASU 2011-04). The amendments in this ASU are intended to improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and International Financial Reporting Standards (“IFRS”). The amendments in this ASU explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. This ASU is to be applied on a prospective basis for interim and annual periods beginning after December 15, 2011. Early application is not permitted. The Company adopted the provision of ASU 2011-04, but such adoption did not have an impact on the financial statements or results of operations.