ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You
should read the following management discussion and analysis (“MD&A”) together with the risk factors set forth in Item
1A and with our audited Consolidated Financial Statements and Notes thereto included elsewhere herein.
Overview
Applied Energetics, Inc.,
specializes in the development and manufacture of advanced high-performance lasers, high voltage electronics, advanced optical systems,
and integrated guided energy systems for prospective defense, national security, industrial, and scientific customers worldwide.
Gregory J. Quarles serves as our President and Chief Executive officer
and, pursuant to a consulting agreement with an LLC wholly owned by him, Dr. Stephen W. McCahon serves as our Chief Scientist. AERG has
continued to expand its technical capabilities with the addition of employees, consultants and contractors, and agreements with several
of the leading laser and optics universities in the country. The team at Applied Energetics continued to expand during the third and fourth
quarters of 2021 and early 2022, with the addition of two new full-time employees (one, a laser technician and the other a junior scientist
and in-house counsel as well as retention of world-class contractors to strengthen our human resources, compliance, public relations,
IT, and technical staff supporting the research and development in the laboratory.
AERG owns intellectual property that is integral and necessary for
the development of Ultrashort Pulse (“USPTM”) Lasers, Laser Guided Energy (“LGE®”) and Direct
Discharge Electrical products for military and commercial applications. AERG currently owns 26 patents and an additional 11 Government
Sensitive Patent Applications (“GSPA”). These GSPA’s are held under secrecy orders of the US government and allow the
company greatly extended protection rights, including having no expiration date until such time as they are no longer classified after
that they will have the normal 20-year patent protection. The company also has seven provisional patents, and we continue to file patent
applications as we deem appropriate.
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We submitted multiple proposals to various government agencies in 2020
and 2021. Due to the closures of multiple agencies and work-from-home orders across various regions of the United States, reviews and
funding decisions on these proposals were delayed longer than anticipated as resources were focused on other matters within the government.
AERG has received multiple notices from government agencies stating that “the vast number of proposals received, and the challenges
posed by the COVID-19 pandemic have impacted the Government’s evaluation timelines.” Several of the government agencies that
have received and are reviewing our proposals started to open their facilities to limited off-site briefings starting on June 1, 2021.
Since that date, AERG’s team has been invited to, and completed, multiple briefings focused on our capabilities and our submissions.
This positive action by the agencies could be impacted by the new Delta variant (B.1.617.2) of the SARS-CoV-2 strain. The Federal government
is currently evaluating the possibility of reducing staff sizes in the offices and closing off all external visitors unless the meetings
are deemed critical by the agency. Effective August 2, 2021, the DOD re-enforced a maximum telework position for their employees and contractors
and reduced the on-site occupancy to less than 50% of the normal occupancy. As the Delta variant increased, the DOD maintained the maximum
telework policy and on September 9, 2021 reduced the maximum on-site occupancy to less than 40% of normal work occupancy. Further restrictions
were announced on January 6, 2022, with maximum occupancy of facilities dropping to 25%, and a majority of workers teleworking, but in
March 2022, the DOD has announced that occupancy is back to 50% except in certain circumstances. These recent changes have again further
hampered the ability of the AERG team to schedule on-site briefings for our proposals undergoing review.
In addition to these review-based delays, the US federal budget for
2022 was not approved by Congress by the October 1, 2021, start of the U.S. federal government fiscal year. On September 21, 2021, the
U.S. House of Representatives passed H.R. 5305, and on September 30, 2021, the U.S. Senate passed the same bill, a continuing resolution
(CR) to extend federal government funding through December 3, 2021, and the President signed it into law (Public Law 117-43) on September
30, 2021 to avoid a government shutdown at the end of the fiscal year 2021. A second CR was signed into law on December 2, 2021, extending
funded operations through February 18, 2022. And most recently, a third CR was signed on February 17, 2022, extending funding through
March 11, 2022. The final appropriations bill was signed into law by President Biden on the night of March 11, 2022, and includes increases
in areas of particular interest to the company.
In May 2021, we moved
into our new headquarters consisting of approximately 13,000 rentable square feet of office, laboratory and production space located
at the University of Arizona Tech Park, a research and technology park owned and operated by the University of Arizona. This has
enabled us to consolidate our offices and expand our R&D capacity with a Class 1000 (ISO Class 6) “clean room” and
other turnkey laboratory and conference features. We have consolidated from our two previous locations and now have our management
and scientific teams under one roof. We also hosted our 2021 Annual Meeting of Stockholders in the large University of Arizona Tech
Park Conference Center, which provided the necessary equipment and refreshments. Attendees at the meeting received tours of the tech
park grounds. We entered into the Lease Agreement for the space, effective March 15, 2021, with Campus Research Corporation. The
lease term began May 1, 2021, and ends on April 30, 2026. The base rent is $6.7626 per rentable square foot for year one, and
escalates to $9.2009 in year two, $11.4806 in year three, $13.1740 in year four and $14.9306 in year five, plus certain operating
expenses and taxes.
On April 28, 2020, AERG was
awarded a loan for $132,760 through the Small Business Administration (SBA) Paycheck Protection Program (PPP). The terms of this loan
were twenty-four months with a 1% annual interest rate. These funds were issued to cover payroll costs over 8 weeks of May and June 2020.
Through the utilization of this PPP loan, AERG was able to keep all employees fully engaged during these two months of the pandemic. Having
followed the guidelines set forth by the SBA on the PPP program, we received a waiver which allowed for the conversion of $80,593.55 of
the loan to a grant. Since then, we have been repaying the balance of the loan in monthly installments at the 1% annual interest rate.
As of December 31, 2021, $22,804 in principal and $1,385 in interest remained outstanding, and we expect to repay the remaining balance
in April 2022.
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Strategic Plan and Analysis
Our goal with the AERG Strategic
Plan is to increase the energy, peak power and frequency agility of USP optical sources while decreasing the size, weight, and cost of
these systems. We are in the process of developing this breadth of very high peak power USP lasers and additional optical sources that
have a very broad range of applicability for threat disruption for the Department of Defense, the intelligence community, and for commercial,
biomedical, space and national intelligence applications. Although the historical market for AERG’s USP technology is the U.S. Government,
derivatives of these USP technologies could provide future platforms for commercial additive and subtractive manufacturing and medical
device and imaging markets, creating larger dual-use market for our products to address once testing, evaluation and integration have
been completed in partnerships with the user community. During 2020, the AERG team was able to develop partnership and teaming arrangements
with the three leading laser and optics institutes in the United States, namely, the University of Arizona, the University of Central
Florida, and the University of Rochester Laboratory for Laser Energetics. Our desire is to work on programs jointly where the strengths
of each organization can assist in escalating knowledge and delivery of systems to the government sponsors, and to train the next generation
of scientists and engineers to work in the Directed Energy fields.
The Coronavirus (COVID-19) pandemic continues to present risks and
uncertainties that may alter or otherwise affect our path forward. Although the virus seemed to be waning in the fall of 2021, the onslaught
of the Omicron variant brought about a new wave that saw the seven-day moving average of new cases peak at around 466,000 during the winter
of 2021-22. This variant, which presented with less severe symptoms on average than those before it, seems now to have receded. However,
it is impossible to be certain whether a new variant will arise, its level of infectiousness and severity, and how it will affect commerce
and our economy. Accordingly, our management continues to monitor the possible effects of the virus on the execution of our plan of operations,
our prospective contracts, and the availability of financing to fund our strategic and operational plans going forward. We attempt to
follow the most current advice and guidance to minimize the risk of infection to our employees and follow any applicable federal guidelines.
Despite the challenges posed by COVID-19, we have continued to execute
our business development plans, further our research and development program and submit proposals for grants and contracts. During the
past two fiscal years, we submitted multiple proposals and have been engaged in meetings on a daily and weekly basis with various agencies
and departments both remotely and in person in Washington, DC and at various other government facilities. Dr. Quarles, our President and
CEO, has traveled to DC on multiple occasions during the pandemic in 2020 and 2021 and currently in 2022 and remains committed to pursuing
this business even in these challenging times. The interest in our technology and applications remains high, and we continue to submit
proposals for all appropriate opportunities and share our vision of the disruptive capabilities of USP optical sources for both near-
and far-term threats and dual-use commercial applications.
Through our analysis of the
market, and in discussions with potential customers, we would also conclude that customers are becoming more receptive and interested
in directed energy technologies. According to the Department of Defense fiscal 2019 budget, its directed energy spending grew from approximately
$500 million in 2017 to over $1 billion in 2019, an increase of 100%. The 2020 budget reflected directed energy spending of $1.2 billion,
an additional increase of 20% over 2019, and from 2017 through 2020, the directed energy budget grew from approximately $500 million to
approximately $1.2 billion, averaging approximately 40% per year. The government has allocated $1.4 billion for various directed energy
programs in 2021, and it has been anticipated to exceed $10.1 billion by 2026. The DOD budget for directed energy was essentially flat
between 2021 and 2022, approaching $1.2 billion for each year. As a result, we continue to be even more optimistic about our future and
the growing opportunities in directed energy applications. The AERG team anticipates a continuation of strong funding for the Directed
Energy community. With our existing patent portfolio, and through further advancements of our technologies, we believe we have the substantial
building blocks needed to become a significant and successful developer in our USPTM and LGE® marketplaces.
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Critical Accounting Policies
Use of Estimates
The preparation of consolidated
financial statements in conformity with United States generally accepted accounting principles requires management to make estimates,
judgments and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management bases its assumptions
on historical experiences and on various other inputs and estimates that it believes 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. In addition, management considers the basis and methodology used in developing and selecting these estimates, the trends in and
amounts of these estimates, specific matters affecting the amount of and changes in these estimates, and any other relevant matters related
to these estimates, including significant issues concerning accounting principles and financial statement presentation. Such estimates
and assumptions could change in the future as more information becomes known which could impact the amounts reported and disclosed herein.
Share-Based Payments
Stock-based compensation cost
is measured at grant date, based on the fair value of the award and is recognized as an expense over the requisite service period.
The fair value of each option
grant is estimated at the date of grant using the Black-Scholes-Merton option valuation model. We make the following assumptions relative
to this model: (i) the annual dividend yield is zero as we do not pay dividends on our common stock, (ii) the weighted-average expected
life is based on a midpoint scenario, where the expected life is determined to be half of the time from grant to expiration, regardless
of vesting, (iii) the risk free interest rate is based on the U.S. Treasury security rate for the expected life, and (iv) the volatility
is based on the level of fluctuations in our historical share price for a period equal to the weighted-average expected life. We estimate
forfeitures when recognizing compensation expense and adjust this estimate over the requisite service period should actual forfeitures
differ from such estimates. Changes in estimated forfeitures are recognized through a cumulative adjustment, which is recognized in the
period of change and which impacts the amount of unamortized compensation expense to be recognized in future periods.
Income Taxes
Deferred tax assets and liabilities
are recognized currently for the future tax consequences attributable to the temporary differences between the financial statement carrying
amounts of assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be recovered or settled. A valuation allowance is recorded
to reduce the carrying amounts of deferred tax assets if it is more likely than not that such assets will not be realized.
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Results of Operations
Our consolidated financial
information for the years ending December 31, 2021, and 2020 is as follows:
Operating Expenses:
Other income/(expense):
Provision for income taxes - -
Revenue
Revenue decreased approximately $176,000 to $0 for the year ended December
31, 2021, compared to $176,000 for the year ended December 31, 2020, primarily due to the completion of an STTR phase I project during
2020.
Cost of Revenue
Cost of revenue decreased approximately $154,000 to $0 for year ended
December 31, 2021, compared to $154,000 for year ended December 31, 2020, primarily due to the completion of an STTR phase I project.
General and Administrative
General and administrative
expenses increased approximately $204,000 to $4,903,000 for the year ended December 31, 2021, compared to $4,699,000 for the year ended
December 31, 2020, primarily due to the $154,000 in applied project costs in 2020, increases in building costs by $278,000, wages and
employee benefits of $90,000, supplies and insurance of $22,000, travel of $14,000, partially offset by a decrease in consulting and professional
services by approximately $356,000.
Selling and Marketing
Selling and Marketing expenses increased approximately $21,000 to $317,000
for the year ended December 31, 2021, compared to $296,000 for the year ended December 31, 2020, primarily due to the continuation of
business development activities through our Master Services Agreement with Westpark Advisors as well as the addition of other consultants
in this field.
Research and Development
Research and development expenses
increased approximately $15,000 to $282,000 for the year ended December 31, 2021, compared to $267,000 the year ended December 31, 2020,
primarily due to the additional labor being performed on our Internal Research and Development project, partially offset by the allocation
of part of management’s pay from research and development to consulting expense.
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Other Expense
Other income/(expense) decreased
approximately $1,932,000 to $77,000 for the year ended December 31, 2021, compared to $2,009,000 for the year ended December 31. 2020,
primarily due to the company receiving $3,206,000 in a litigation settlement during 2020. Interest expense decreased by approximately
$1,208,000 to $4,000 for the year ended December 31, 2021, compared to $1,213,000 for the year ended December 31, 2020 primarily due to
the amortization of the note’s payable beneficial conversion feature. Other income increased approximately $65,000 to $81,000 for
the year ended 2021, compared to $16,000 for the year ended December 31, 2020 primarily due the CARES Act PPP Loan forgiveness for $81,000.
Net Loss
Our operations in 2021 resulted
in a net loss of approximately $5,425,000, a decrease of approximately $2,195,000 compared to the approximately $3,230,000 net loss for
2020 primarily due to the receipt of a ligation settlement, a decrease in consulting and professional services and applied project costs,
partially offset by an increase due to the recognition of a beneficial conversion feature, increases in employee wages and benefits, building
costs and supplies and insurance, selling and marketing. Our net loss attributable to common stockholders per common share – basic
and diluted decreased to approximately ($0.03) per share.
Trend Discussion
There are obvious costs associated
with restarting the corporation and acquiring the skilled leadership and manpower to execute on new product development, as is visible
in the higher year-over-year expenses recognized in this Result of Operations. It appears with early 2021 contract booking and the combination
of the government slow-down due to COVID-19 impacts that it is too early to determine if efforts to obtain new business under our Teaming
and Consulting Agreements could be successful for the next fiscal year. The AERG team has expanded teaming arrangements in 2021, with
agreements signed with the three most prominent optics and laser universities in the United States. This should provide greater visibility
to government agencies looking for submissions with university/industry partnerships and research alignment.
Liquidity and Capital Resources
Going Concern
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. For the
year ended December 31, 2021, the company incurred a net loss of approximately $5,425,000, had negative cash flows from operations of
approximately $3,214,000 and may incur additional future losses due to the reduction in Government contract activity. At December 31,
2021, the Company had total current assets of approximately $3,706,000 and total current liabilities of approximately $1,416,000 resulting
in working capital of approximately $2,290,000. At December 31, 2021, the Company had cash of approximately $3,663,000.
Based on the Company’s current business plan, it believes its
cash balance as of the date of this filing will be sufficient to meet its anticipated cash requirements for the next twelve months. However,
there can be no assurance that the current business plan will be achievable. Such conditions raise substantial doubts about the Company’s
ability to continue as a going concern for one year from the date the financial statements are issued.
The company’s existence
is dependent upon management’s ability to develop profitable operations. Management is devoting substantially all of its efforts
to developing its business and raising capital and there can be no assurance that the company’s efforts will be successful. No assurance
can be given that management’s actions will result in profitable operations or the resolution of its liquidity problems. The accompanying
consolidated financial statements do not include any adjustments that might result should the company be unable to continue as a going
concern. The ongoing COVID-19 pandemic contributes to this uncertainty.
18
In order to improve the company’s
liquidity, the company’s management is actively pursuing additional equity financing through discussions with investment bankers
and private investors. There can be no assurance that the company will be successful in its effort to secure additional equity financing.
The financial statements do
not include any adjustments relating to the recoverability of assets and the amount or classification of liabilities that might be necessary
should the company be unable to continue as a going concern.
As of December 31, 2021, we
had approximately $3,663,000 cash and cash equivalents, an increase of approximately $339,000 from December 31, 2020. In 2021, we used
approximately $3,214,000 in operating activities, comprised primarily of our net loss of $5,425,000, a decrease in prepaid expenses and
deposits of $60,000, an increase in accounts payable of $43,000, an increase in accrued interest of $1,000, an increase in accrued expenses
of $21,000, partially offset by non-cash stock-based compensation expense of $1,237,000, amortization of future compensation payable of
$833,000, amortization of prepaid assets of $157,000 and depreciation and amortization of $20,000.
We had approximately $3,760,000 provided by financing
activities comprised of $5,299,000 provided from the proceeds from the issuance of common stock and $108,000 provided from the proceeds
from the exercise of warrants, partially offset by the repayment on notes payable $1,647,000. All this resulted in a net cash inflow of
approximately $3,760,000. There were no cash proceeds from the exercise of stock options during the year ended December 31, 2021.
As of March 30, 2022, our
backlog (that is, workload remaining on signed contracts) was approximately $-0- to be completed within the next twelve months.
As of March 30, 2022, the
company had a cash balance of $2,750,000.
Contractual Obligations:
The following table summarizes
our contractual obligations and other commercial commitments as of December 31, 2021:
Payment by Period
Total Less than 1 Year 1 to 5 Years
The above table does not include
the dividends on our Series A Preferred Stock. Assuming that there is no conversion of the outstanding shares of Series A Preferred Stock
into shares of common stock, the dividends are approximately $34,000 each year (approximately $9,000 each quarter).
Leases
In March 2021, the Company
signed a five-year lease for a 11,000 square foot laboratory/office space in Tucson. The lease term commences May 1, 2021 and ends on
April 30, 2026. The base rent is $6.7626 per rentable square foot for year one, and escalates to $9.2009 in year two, $11.4806 in year
three, $13.1740 in year four and $14.9306 in year five, plus certain operating expenses and taxes.
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Preferred Stock
The Series A Preferred Stock
has a liquidation preference of $25.00 per share. The Series A Preferred Stock bears dividends at an initial rate of 6.5% of the liquidation
preference per share per annum, which accrues from the date of issuance, and is payable quarterly. We have not paid dividends commencing
with the quarterly dividend due August 1, 2013 and, as a result, the dividend rate has increased to 10% per annum and will remain at that
level until such failure is cured. Dividends due as of December 31, 2021, and February 28, 2022, were approximately $295,000 and $298,000,
respectively.
The holders of the Series
A Preferred Stock have a right to put the stock to the company for an aggregate amount equal to the liquidation preference (approximately
$340,000) plus unpaid dividends of $295,000, as of December 31, 2021, in the event of a change in control. Dividends are payable in: (i)
cash, (ii) shares of our common stock (valued for such purpose at 95% of the weighted average of the last sales prices of our common stock
for each of the trading days in the ten trading day period ending on the third trading day prior to the applicable dividend payment date),
provided that the issuance and/or resale of all such shares of our common stock are then covered by an effective registration statement
or (iii) any combination of the foregoing. As of December 31, 2021, there were 13,602 shares of Series A Preferred Stock outstanding.
Recent Accounting Pronouncements
Refer to Note 2 of Notes to
Consolidated Financial Statements for a discussion of recent accounting standards and pronouncements.
Off-Balance Sheet Arrangements
As of December 31, 2021, we
had no significant off-balance sheet arrangements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
In the normal course of business,
our financial position is subject to a variety of risks, such as the ability to collect our accounts receivable and the recoverability
of the carrying values of our long-term assets. We do not presently enter into any transactions involving derivative financial instruments
for risk management or other purposes.
Our available cash balances
are deposited in bank demand deposit accounts. Substantially all of our cash flows are derived from our operations within the United States
and today we are not subject to market risk associated with changes in foreign exchange rates.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Consolidated Financial
Statements, the related notes and the Report of Independent Registered Public Accounting Firms thereon, are included in Applied Energetics’
2021 Consolidated Financial Statements and are filed as a part of this report on page F-1 following the signatures.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A. CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and
Procedures
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Our management, with the participation of our Chief Executive and Principal
Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2021. The term “disclosure
controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange
Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by
a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time
periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act
is accumulated and communicated to the company’s management, including its chief executive and principal financial officers, as
appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter
how well-designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies
its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on that evaluation our Chief Executive
Officer and Principal Financial Officer concluded that our disclosure controls and procedures were not effective as of December 31, 2021.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible
for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) or 15d-15(f)
under the Exchange Act. Internal control over financial reporting is a process designed by, or under the supervision of, our chief executive
and principal financial officers and effected by our Board of Directors, management and other personnel, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that:
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 Chief Executive and Principal Financial Officer (“CEO/PFO”), has conducted an assessment of the effectiveness of our internal
control over financial reporting as of December 31, 2021, based on the framework established in Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework). This assessment included an evaluation
of the design of our internal control over financial reporting and testing of the operational effectiveness of those controls. Based on
our assessment under the criteria described above, the CEO/PFO has concluded that our internal control over financial reporting was not
effective as of December 31, 2021.
This Annual Report on Form
10-K does not include an attestation report of our registered public accounting firm regarding internal controls over financial reporting.
Management’s report was not subject to attestation by our registered public accounting firm pursuant to the SEC rules that permit
smaller reporting companies to provide only management attestation in annual report on Form 10-K.
Changes in Internal Control Over Financial Reporting
There has been no change in Applied Energetics’ internal control
over financial reporting for the quarter ended December 31, 2021, that materially affected, or is reasonably likely to materially affect
our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
Not Applicable
ITEM 9C. DISCLOSURE REGARDING FOREIGN JURISDICTIONS THAT PREVENT
INSPECTIONS.
Not Applicable
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PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following is information with respect to our executive officers
and directors:
Name Age Principal Position Director, Term expiring in
Bradford T. Adamczyk 53 Director and Executive Chairman Three years
Jonathan R. Barcklow 38 Director, Vice President and Secretary Two years
John E. Schultz Jr. 68 Director Less than one year
Mary P. O’Hara 55 Director, General Counsel and Chief Legal Officer Three years
Stephen W. McCahon 62 Chief Scientist and Consultant N/A
Messrs. Adamczyk and Barcklow joined the board
in March 2018. Mr. Schultz joined the board in November 2018. Dr. Quarles joined the board in May 2019. Ms. O’Hara joined the board
in August 2021. Dr. McCahon was retained as a consultant effective May 2019 and serves in such capacity as our Chief Scientist.
Bradford T. Adamczyk:
Mr. Adamczyk was elected as the Company’s Chairman in May 2019 and Executive Chairman in November 2022. He served as Principal
Executive Officer from August 6, 2018, until becoming Chairman and was elected as a Company director on March 8, 2018. Mr. Adamczyk has
over 25 years of experience in investments and financial analysis. He founded MoriahStone Investment Management in 2013. MoriahStone
Investment Management specializes in both public equities and small-cap private companies. He has also served on the board of advisors
of BroVo Spirits, LLC since 2014, becoming its Chairman in 2018. Prior to founding MoriahStone, he was a senior securities analyst at
Columbus Circle Investors in Stamford, CT, where he focused on technology investments. Mr. Adamczyk started his financial career at Morgan
Stanley after receiving his MBA from the University of Michigan. He received his undergraduate degree from Western Michigan University,
graduating Magna Cum Laude.
Gregory J Quarles:
Dr. Quarles was elected as the Company’s Chief Executive Officer and as a Company director effective May 4, 2019. In January 2021,
the Board also elected him as President of the Company. Prior to that time, he had served on the Company’s Scientific Advisory
Board since March 18, 2017. Before joining Applied Energetics, Dr. Quarles spent the previous six years with The Optical Society of America
(“OSA”) in Washington D.C., both as a member of the Board and the Executive Committee and more recently as the Chief Scientific
Officer. His responsibilities at OSA encompassed a broad range of scientific, technical and engineering infrastructure, and included
content development for the OSA meetings portfolio, along with many other related projects, highlighted by his reports to Congress. Moreover,
Dr. Quarles had been personally involved through OSA in the establishment of many crucial partnerships involving major R&D laboratories
and global agencies worldwide. This involvement included being a long-standing member of the U.S. Department of Commerce, Bureau of Industry
and Security, and Sensors and Instrumentation Technical Advisory Committee. In addition to his executive leadership, Dr. Quarles is a
well-respected member of the laser development community globally with over 30 years of experience since the award of his Ph.D. from
Oklahoma State University. He is a Fellow in both the SPIE and the IEEE Photonics Society and received the Memorial D.S. Rozhdestvensky
Medal from the Russian Optical Society (2015). In 2016, he joined the Oklahoma State University CAS Hall of Fame, and in 1996 received
the R&D 100 Award for the Ce:LiSAF Laser System.
Jonathan R. Barcklow:
Mr. Barcklow was elected as the Company’s Vice President and Secretary on November 12, 2018, and was elected as a Company director
on March 8, 2018. Mr. Barcklow has over 15 years of experience in advisory and management consulting services in federal defense and
civilian agencies. He has spent his career in consulting services with both PriceWaterhouseCoopers and KPMG, LLP. Mr. Barcklow has worked
at KPMG since 2010 and currently serves as the Managing Director within KPMG’s Federal Management Consulting group leading their
Defense Mission Services portfolio. In leading this $30M portfolio, Mr. Barcklow is responsible for every facet of the businesses operations,
management, profitability and growth planning and oversees a diverse workforce of 150 professionals Over his career, Mr. Barcklow has
been a consultant for a number of federal agencies, including the Department of Veterans Affairs, Department of Homeland Security, Federal
Emergency Management Agency, National Science Foundation, Department of the Navy, US Marine Corp, US Air Force, Defense Logistics Agency,
Office of the Secretary of Defense, and the Deputy Chief Management Office. His portfolio primarily focused on large-scale strategic
transformations, technology and innovation, including big data, advanced analytics, AI and machine learning, blockchain, and Internet
of Things (IoT) within DoD entities. Additionally, Mr. Barcklow helped drive the initial recapitalization efforts of Applied Energetics
in 2018 and developed the initial 12-month execution plan for the Company’s turnaround. Mr. Barcklow graduated from the University
of Virginia.
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John E. Schultz Jr.
Mr. Schultz was elected as a Company director on November 11, 2018. Mr. Schultz has had a long affiliation with Wall Street, having founded
CSG Spectra, Inc., a risk analytics firm, in 1984. He also founded Oak Tree Asset Management Ltd. in 2000, where he actively trades securities
in managed LLC’s. Mr. Schultz’s strong networks have emphasized outside-the-box investment opportunities and early-stage
new frontier private equity investment deals. Mr. Schultz has an intimate knowledge of Applied Energetics, including its history and
financials and has in the past served as a consultant to the Company. Mr. Schultz is a graduate of California State University at Long
Beach.
Mary P. O’Hara
Ms. O’Hara was appointed to the Board of Directors on August 20, 2021, upon the board’s decision to expand its number to
five members. She has been in private law practice for over thirty years and has broad experience in all facets of securities, corporate
and commercial law. She is currently affiliated with the law firm of Masur, Griffitts, Avidor, LLP and has represented the Company for
several years. Previously, she was a partner at Hodgson Russ LLP and an associate at Fulbright & Jaworski LLP (now known as Norton
Rose Fulbright) and Mayer Brown & Platt, LLP (now known as Mayer Brown LLP). Ms. O’Hara has a J.D. from New York University
School of Law and B.A. in Economics, magna cum laude, from the University of New Mexico.
Stephen W. McCahon Dr.
Stephen McCahon has been a scientific researcher, technology developer, and entrepreneur for over 30 years. He has co-authored more than
50 scientific publications and has more than 30 patents issued, patents pending, or invention disclosures in preparation for patent submission.
He was a Member of the Research Staff in the Optical Physics Department at the Hughes Research Laboratory in Malibu, California from
1986 to 1996 performing basic research in the area of optical physics and non-linear optical materials. In 1996, Dr. McCahon moved to
Raytheon (Hughes) Missile Systems Co, in Tucson, AZ during which time as was significantly responsible for the successful creation and
development of the Directed Energy Weapons Product Line and served as its Chief Scientist. He left Raytheon in 2002 to co-found Applied
Energetics Inc. in Tucson, AZ to develop Directed Energy Weapons for the DoD including very high energy and average power USP laser sources
and Laser Guided Energy Technologies. In April 2010 Dr. McCahon left Applied Energetics to form Applied Optical Sciences where he developed
technologies related to the application of optical physics to a broad range of areas, including photonics and USP laser development.
Dr. McCahon is a graduate the University of Southern California (BSEE, MSEE) holds a Ph.D., Photonics, Inter-disciplinary Physics and
Electrical Engineering from the University of Iowa. Since February 2016, he has served as a consultant to the Applied Energetics Board
of Directors. In 2019 Applied Energetics purchased his company Applied Optical Sciences and integrated it into Applied Energetics where
Dr. McCahon currently serves as its Chief Scientist.
Directors Qualifications, Experience and Skills
Our directors bring to our
Board a wealth of executive leadership experience and technical knowledge derived from their service, respectively, as senior executives,
founders of industry and legal or financial professionals. Our board members have demonstrated strong business acumen and an ability
to exercise sound judgment and has a reputation for integrity, honesty and adherence to ethical standards. When considering whether directors
and nominees have the experience, qualifications, attributes and skills, taken as a whole, to enable the Board of Directors to satisfy
its oversight responsibilities effectively in light of the Company’s business and structure, the Corporate Governance and Nominating
Committee and the Board of Directors focused primarily on the information discussed in each of the Directors’ individual biographies
set forth above and the specific individual qualifications, experience and skills as described below:
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Section 16(A) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires certain
officers and directors of Applied Energetics, and any persons who own more than ten percent of the common stock outstanding to file forms
reporting their initial beneficial ownership of shares and subsequent changes in that ownership with the SEC. Officers and directors of
Applied Energetics, and greater than ten percent beneficial owners are also required to furnish us with copies of all such Section 16(a)
forms they file. None of our officers or directors failed to file any Section 16(a) forms.
Code of Ethics
Applied Energetics has adopted
a Code of Business Conduct and Ethics that applies to all of Applied Energetics’ employees and directors, including its chief executive
officer, principal financial officer and principal accounting officer. Applied Energetics’ Code of Business Conduct and Ethics
covers all areas of professional conduct including, but not limited to, conflicts of interest, disclosure obligations, insider trading,
confidential information, as well as compliance with all laws, rules and regulations applicable to Applied Energetics’ business.
Our Code of Ethics and Business
Conduct is available upon request made to us in writing at the following address, and will be provided without charge:
Applied Energetics, Inc.
Attention: Compliance Officer
9070 S. Rita Road, Suite 1500
Tucson, AZ 85747
Committees of the Board of Directors
The members of the board
of directors continue to evaluate the need and utility of establishing one or more committees of the Board of Directors and to review
relevant legal or regulatory requirements with respect thereto. At present all functions that would be fulfilled by committees are being
fulfilled by the entire board, and the board believes that currently no committees are necessary or legally required.
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ITEM 11. EXECUTIVE COMPENSATION
Summary Compensation Table
The following table discloses
the compensation for the persons who served as our President and Chief Executive Officer (and Principal Financial Officer), Executive
Chairman and Vice President and Secretary for the years ended December 31, 2021 and 2020, Gregory J Quarles had been our Chief Executive
Officer from May 6, 2019 to present and was elected President as of January 2021. Messrs. Adamczyk and Barcklow also receive compensation
as directors as set forth under Director Compensation below.
Bradford T. Adamczyk, 2021 $ - $ - $ - $ $ -
Executive Chairman 2020 $ $ - $ $ $ -
Jonathan R. Barcklow, 2021 $ - $ - $ - $ - $
Vice President and Secretary 2020 $ - $ - $ - $ - $ -
Director Compensation
The following table discloses our director compensation
for the years ended December 31, 2021 and 2020:
General Counsel and CLO 2020 $ - $ - $ - $ - $ -
Board Considerations in Determining Salaries
During the fourth quarter
of 2020, our Board of Directors retained Innovative Compensation and Benefits Concepts, LLC and its principal, Robert B. Jones, to gather
the necessary data, including review of relevant company information, the level of work contributed by each director, and compensation
levels among peer companies, and render two separate reports with recommendations on appropriate compensation levels for each member
of our Board of Directors as well as our current and possible future executive officers. The Board considered these recommendations carefully
before implementing the Board compensation and the amendments to Dr. Quarles’s Executive Employment Agreement. The Board periodically
solicits input from Mr. Jones in making compensation decisions.
The various levels of compensation among members of the Board of Directors
reflect the number of hours dedicated by each director and special assignments and projects undertaken by each on behalf of the company.
Mr. Adamczyk’s compensation as Executive Chairman consists of a board retainer of $150,000, and he receives an additional $65,000
for his assumption of capital and corporate finance and investor relations duties. Mr. Schultz’s compensation consists of a board
retainer of $75,000, and he receives an additional $15,000 for his service intending to legal affairs, accounting and information technology
for the company. Mr. Barcklow’s compensation consists of a board retainer of $75,000, and he receives an additional $35,000 for
his service as Secretary, marketing and information technology.
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Employment Agreements for Named Executive Officers and Chief Scientist
As of April 18, 2019, we
entered into an Executive Employment Agreement with Dr. Gregory J Quarles setting forth the terms of his service as Chief Executive Officer.
The agreement is for a term of three years and is renewable thereafter for sequential one-year periods. The agreement may be terminated
by the company for “cause” or by Quarles for “Good Reason” both of which terms are defined in the agreement.
The agreement may also be terminated, without cause or Good Reason, by either party upon sixty days’ written notice to the other.
The agreement calls for (i)
a cash salary of $250,000 per annum, payable monthly, and eligibility for a discretionary bonus within 60 days of the end of each year,
and (ii) options to purchase up to 5,000,000 shares of our common stock at an exercise price of $0.35 per share. These options were issued
pursuant to a grant agreement, dated as of April 18, 2019 and vest immediately with respect to 500,000 shares and in semi-annual installments
with respect to the remaining 4,500,000 shares. The agreement also provides for Quarles to retain 2,000,000 options previously granted
to him under a Consultant Stock Option Agreement in 2017, for his services on the Scientific Advisory Board, which are subject to vesting
based on achievement of performance milestones. Dr. Quarles forfeited options to purchase an additional 1,500,000 shares under another
prior option agreement. Under the agreement, Dr. Quarles also is to receive health and life insurance as well as other standard benefits.
The agreement also requires the company to reimburse certain out-of-pocket expenses and to compensate Quarles in the event that it requires
him to resign from certain boards on which he serves.
In the event of a termination of the agreement by Quarles with Good Reason, or by
us without cause, we must pay him any unpaid base compensation due as of the termination date as well as any pro rata unpaid bonus and
any unpaid expenses. Any unvested options will vest upon such termination. In such event, we must continue to pay Dr. Quarles his monthly
base compensation and any health and life insurance benefits until he has secured full-time employment, but not to exceed a period of
three months from the termination date.
In the event that we terminate
the agreement for cause or he terminates without Good Reason, he will receive base compensation and expense reimbursement through the
date of termination but will forfeit any unvested equity compensation.
This agreement was amended
December 15, 2020, increasing Dr. Quarles’ salary to $300,000 per year effective January 1, 2021, and again on November 30, 2021,
increasing his salary to $350,000 per year effective January 1, 2022.
Stephen W. McCahon serves
as our Chief Scientist, pursuant to a Consulting Agreement, dated as of May 24, 2019 (the “SWM Consulting Agreement”), of
which he is the principal. The SMW Consulting Agreement provides for a combination of cash and equity compensation for which Dr. McCahon
leads Applied Energetics’ scientific efforts including: leading the scientific team, developing new intellectual property, assisting
with business development, transferring legacy knowledge to new team members, recruiting and training talent, working with executives
on corporate strategy, assisting in budget development for R&D, meeting with clients on technical concepts, attending conferences,
and producing thought leadership for the Company. Dr. McCahon works closely with Dr. Quarles on the Company’s research and development
activities and in the proposal and fulfilment of research and development contracts for branches of the Department of Defense, agencies
of the federal government and other defense contractors and in other internal research and development activities relating to lasers
and advanced optical sources.
The SWM Consulting Agreement
provides for Mr. McCahon’s service to the Company for compensation consisting partly of cash of $180,000 for the first year and
$250,000 during each of the second and third years of the term. Under the SWM Consulting Agreement, the Company also repurchased 5,000,000
shares if its common stock, issued to Dr. McCahon in 2016 under a prior Consulting Agreement, at a price of $0.06 per share based on
the Company share price at the time of the SWM Consulting Agreement. 5,000,000 of an additional 15,000,000 shares held by Dr. McCahon
are subject to a lock-up and released pro rata each month during the term of the agreement which may be accelerated in the event of termination
other than for cause or a change in control. The term of the SWM Consulting Agreement began on June 1, 2019, and extends for a period
of 36 months thereafter. Dr. McCahon is entitled to continue receiving cash compensation for three months following the date of any termination
without cause by the Company.
Also, effective May 24, 2019,
and in connection with the entry into the SWM Consulting Agreement, the Company entered into an Asset Purchase Agreement with Applied
Optical Sciences, Inc. (“AOS”), an Arizona corporation of which Stephen W. McCahon is the majority stockholder. The Asset
Purchase Agreement provided for purchase of specified assets from AOS, including principally intellectual property, contracts and equipment
in exchange for consideration consisting of (i) cash in the amount of $2,500,000.00, payable in the form of a Promissory Note, secured
by the assets, and (ii) warrants to purchase up to 2,500,000 shares of Applied Energetics’ common stock at an exercise price of
$0.06 per share. The Promissory Note was amended in February 2021 to extend the maturity date by six months and restructure the payment
to time up to the adjusted maturity date. The amendment also called for waiver of any late payment penalties for the first two payments.
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Dr. McCahon is a significant
stockholder of the Company. See “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.”
Outstanding Equity Awards at Fiscal Year-End
The following table discloses
unexercised options held by the named executives at December 31, 2021:
Option Awards
In addition to the foregoing,
as of December 31, 2021, Bradford T. Adamczyk, director and Chairman of the Board, held options to purchase up to 5,000,000 shares of
common stock, and John Schultz, a director, held options to purchase up to 2,500,000 shares of common stock, each at an exercise price
of $0.07 per share and both of which expire on November 12, 2028. Details regarding these options are set forth in Item 12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters below.
Payments upon Termination or Change-In-Control
There are no termination
or change in control agreements in place that would require payments.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION:
During the fiscal year ended
December 31, 2021, none of our executive officers served on the Board of Directors or the Compensation Committee of any other company
whose executive officers also serve on our Board of Directors or our Compensation Committee.
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS:
The following table sets
forth information regarding the beneficial ownership of our Common Stock, based on information provided by the persons named below in
publicly available filings, as of March 29, 2022:
● each of our directors and executive officers;
● all directors and executive officers of ours as a group; and
Unless otherwise indicated,
the address of each beneficial owner is in care of Applied Energetics, 9070 South Rita Road, Suite 1500, Tucson, Arizona 85747. Unless
otherwise indicated, the company believes that all persons named in the following table have sole voting and investment power with respect
to all shares of common stock that they beneficially own.
For purposes of this table,
a person is deemed to be the beneficial owner of the securities if that person has the right to acquire such securities within 60 days
of March 29, 2022 upon the exercise of options or warrants. In determining the percentage ownership of the persons in the table below,
we assumed in each case that the person exercised all options which are currently held by that person and which are exercisable within
such 60-day period, but that options and warrants held by all other persons were not exercised, and based the percentage ownership on
207,692,878 shares outstanding on March 29, 2022.
All directors and executive officers as a group (6 persons) 39,428,899 18.6 %
*Less than one percent.
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Securities
Authorized for Issuance Under Equity Compensation Plans
The following table details
information regarding our existing equity compensation plans as of December 31, 2021:
Equity Compensation Plan Information
Equity compensation plans not approved by security holders
Effective November 12, 2018,
the board of directors of Applied Energetics, Inc. adopted the 2018 Incentive Stock Plan. On October 30, 2019 the shareholders voted
to approve and adopt the plan. The plan provides for the allocation and issuance of stock, restricted stock purchase offers and options
(both incentive stock options and non-qualified stock options) to officers, directors, employees and consultants of the company. The
board reserved a total of 50,000,000 for possible issuance under the plan.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
Transactions with Related Parties
Except as disclosed herein, no director, executive
officer, stockholder holding at least 5% of shares of our common stock, or any family member thereof, had any material interest, direct
or indirect, in any transaction, or proposed transaction since the year ended December 31, 2021.
Contractual Relationships with Related Parties
Mary P. O’Hara, through her law firm, Masur
Griffitts Avidor, LLP, serves as counsel to the Company, and provides securities, corporate, commercial and general legal services. The
firm bills the Company monthly for such services, and such fees average approximately $22,000 per month.
Although the Company has not yet adopted formal
policies and procedures with respect to related party transactions, the Board evaluates any such situation as it arises. In the case
of Ms. O’Hara’s service as counsel as well as a board member, in accordance with Rule 1.7 of the New York Lawyer’s
Rules of Professional Conduct and Note [35] thereto, the Board and Ms. O’Hara considered (i) the likelihood of a conflict of interest
arising from her service, the potential intensity of any such conflict, the effect of her resignation if necessary, and the possibility
of the Company obtaining legal advice from another attorney in such a conflict situation; and (ii) the risk that matters discussed at
board meetings while she is present in the capacity of director might not be protected by the attorney-client privilege. Ms. O’Hara
provided disclosure to the Board of the risks and possible conflicts involved with the relationship and recommended that the Board seek
guidance from other counsel with respect to the reasonableness of the relationship. The Board then took such advice with respect to such
matters as it deemed appropriate, including obtaining a memorandum from separate counsel regarding the above matters, and concluded that
Ms. O’Hara’s service on the Board posed no significant risk of such conflicts and that alternate counsel would be available
in the event such a conflict did arise.
Dr. Stephen W. McCahon holds in excess of 5% of
our common stock and serves as our Chief Scientist pursuant to a Consulting Agreement with SWM Consulting LLC of which he is the principal.
For a description of this Consulting Agreement, see “Directors and Executive Officers – Chief Scientist” above. See