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 and optical systems, high voltage electronics, and
integrated guided energy systems for prospective defense, national security, industrial, biomedical, 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. AE 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 2022 and into early 2023, with the addition of nine new employees, including its Chief Operating and Financial
Officer, one junior and one midlevel scientist, two laser technicians, a part-time senior product development advisor, an engineering
project manager, in-house counsel, a finance manager and an executive assistant. AE also works with a team of world-class contractors
to strengthen our human resources, compliance, public relations, IT, and technical staff supporting the research and development in the
laboratory.
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AE owns and protects 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. AE currently owns 27 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 which they will
have the normal 20-year patent protection. The company also has seven pending patent applications and one provisional patent application
which is undergoing conversion to its non-provisional form. We continue to file patent applications as we deem appropriate to protect
our intellectual property and enhance our competitive advantage.
During the year ended December
31, 2022, our business development efforts began to come to fruition as AE was awarded a research grant by the U.S. Marine Corps and
a Phase I STTR contract by the U.S. Army. In May 2022, Applied Energetics was awarded a $3.89 million, two-year grant from the Department
of the Navy, Office of Naval Research (ONR), to develop an optical system capable of defeating customer-specified threats for integration
onto U.S. Marine Corps (USMC) platforms. We were awarded this grant to accelerate the development and testing of Infrared (IR) optical
technology with an ultrashort pulse laser (USPL) system. The overall objective is to advance and ruggedize optical technologies that
can be fielded on a variety of USMC platforms and are able to operate in harsh conditions.
We also executed a Phase
I Small Business Technology Transfer (STTR) contract with the U.S. Army on June 2, 2022. The objective of the contract was the delivery
of an ultra-broadband infrared (IR) source. Under this contract, Applied Energetics, modeled novel approaches for the eye-safe delivery
of ultra-broadband infrared laser pulses to electro-optic sensors. Electro-Optical/Infrared (EO/IR) sensors are imaging systems used
for military applications. The STTR program is a federally funded initiative to incorporate small business technological innovation into
government supported research and development programs. STTRs require the small business to team with a university or non-profit and
are structured in three potential phases. Applied Energetics proposed to partner with the James C. Wyant College of Optical Sciences
at the University of Arizona for Phase I.
We began work on each of
these projects and completed the last deliverable under the STTR contract during the year. We anticipate producing all deliverables required
under the grant in a successful and timely manner.
Prior to receiving the above-described
grant and contract, we had experienced delays in responses to multiple proposals we had submitted to government agencies due to the Covid-19
related closures of these agencies and work-from-home orders across various regions of the United States, as resources were focused on
other matters within the government. Since the reopening of proposal reviews and processing, AE’s team has been invited to, and
completed, multiple briefings focused on our capabilities and our submissions. However, this positive action by the agencies could be
reversed as Covid remains an ongoing risk. Any changes to reinstate the closures or work-from-home orders could again hamper the ability
of the AE team to schedule on-site briefings for our proposals undergoing review.
In addition to these review-based
delays, the US federal budgets for both 2022 and 2023 were not approved by Congress by the start of the U.S. federal government fiscal
year, which is October 1 of the preceding year. In September of 2021 and 2022, Congress passed, and the president signed, continuing
resolutions (“CRs”), to extend federal government funding through December 3, 2021, and December 16, 2022, respectively.
On December 2, 2021, a second CR was signed into law, extending funded operations through February 18, 2022, and then 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. Similarly, on December 16, 2022, a second CR for fiscal 2023 was signed into law, extending funding
through December 23, 2022, and on December 22, 2022, a third CR was signed into law, extending funding through December 30, 2022. The
final appropriations bill was signed into law on December 29, 2022 and, as in the prior year’s bill, includes increases in areas
of particular interest to the company. However, the delays and uncertainty around funding may delay allocation of funds or pose a payment
risk for the company under any grants or agreements under which we are already working.
Strategic Plan and Analysis
We
plan to continue building our management team with highly qualified individuals. We intend to recruit additional personnel in the areas
of R&D, science and simulation, marketing and finance, and, possibly add members to our Board of Directors and our Board of Advisors.
We have worked to align key innovations with our roadmap to encourage and enable internal filing for a broad, strategic and robust intellectual
property portfolio and continue surveying the literature for acquisitions of parallel intellectual property to that end. We also intend
to pursue strategic corporate acquisitions in related fields and technology. We continue to explore any favorable equity financing opportunities.
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Our
goal with the Applied Energetics 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, commercial,
and biomedical applications such as biophotonic illumination and imaging. Although the historical market for Applied Energetics’
LGE and USP technology is the U.S. Government, the USP technologies are expected to provide numerous platforms for commercial additive
and subtractive manufacturing and biomedical and imaging markets, creating a substantially larger market for our products to address.
Since 2020, the Applied Energetics 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.
Despite
the challenges posed by COVID-19, we have continued to execute our business development plans, further our research and development program
and submit filings for intellectual property and 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. Having received a significant research grant and an STTR contract during
the second quarter of 2022, we believe 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 remain convinced that customers are becoming more receptive and interested in directed energy technologies.
According to the US Department of Defense fiscal budgets from 2017 through 2023, its directed energy spending grew from approximately
$500 million in 2017 to over $1.695 billion in 2023, an increase of nearly 240%. Market analysis and projections have estimated that
this directed energy sector is anticipated to exceed $10.1 billion globally by 2026. We continue to be optimistic about our future and
the growing opportunities in directed energy applications, especially since this growth to nearly $1.7 B annually is being accomplished
without a recognized Program of Record (POR) for directed energy platforms. Once these technologies are funded in production for a POR,
these DOD budgets for DE will grow exponentially larger to support the technology insertion. The Applied Energetics 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
USP and LGE marketplaces.
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.
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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 approximately 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.
Results of Operations
Our consolidated financial
information for the years ending December 31, 2022 and 2021 is as follows:
Operating expenses:
Other income/(expenses):
Provision for income taxes - -
Revenue
Revenue increased by approximately
$1,308,000 to approximately $1,308,000 for the year ended December 31, 2022 from zero for the year ended December 31, 2021. Revenues
for the 2022 period were from a contract and a grant that we received and commenced performing in June 2022.
Cost of Revenue
Cost of revenue increased
by approximately $306,000 to approximately $306,000 for year ended December 31, 2022, from zero during the year ended December 31, 2021.
This represents costs directly associated with the contract and grant that company commenced in June 2022.
General and Administrative
General and administrative
expenses increased approximately $1,226,700 to $6,130,000 for the year ended December 31, 2022, compared to approximately $4,903,000 for
the year ended December 31, 2021, primarily due to a decrease of approximately $24,000 in professional expenses, an increase in salaries
and employee benefits of approximately $912,000, in IT costs of approximately $22,000, in depreciation expense of approximately $56,000
and in insurance of $67,000. The remaining increase of approximately $198,000 consists of office supplies, equipment rental, travel, meals
and investor relations expenses.
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Selling and Marketing
Selling and Marketing expenses
increased approximately $4,000 to $321,000 for the year ended December 31, 2022, compared to approximately $317,000 for the year ended
December 31, 2021, 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 $39,000 to $321,000 for the year ended December 31, 2022, compared to approximately $282,000 the year ended December
31, 2021, primarily assets that were placed into service during the last two quarters of 2022 that are actively being used to generate
work in progress research and development of the company core technologies.
Other Income/(Expense)
Other income decreased approximately
$80,000 to $(2,000) for the year ended December 31, 2022, compared to $77,000 for the year ended December 31. 2021, primarily due to
the partial forgiveness of the company’s PPP loan.
Net Loss
Our operations in 2022 resulted
in a net loss of approximately $5,772,000, an increase of approximately $346,500 compared to the approximately $5,425,500 net loss for
2021, primarily due to increases in general and administrative and research and development expenses, partially offset by higher revenue
and a decrease in selling and marketing expense.
Trend Discussion
During the year ended December
31, 2022, as we received our ONR grant and STTR contract with the Army, we recognized revenues as we performed these services and also
recorded related costs. Costs under this grant and contract were amplified by ongoing system-wide supply chain disruptions,resulting primarily
from the Covid-19 pandemic, shortages of items like semiconductor chips, and related systemic issues, and general inflation. In particular,
micro-electronic and semiconductor chip shortages are still impacting supply chains, and as such, can impact our ability to execute and
deliver technology to meet demands of our customers. These costs and supply issues also may affect any internal research and development
programs, and we anticipate that they will continue for at least the near term.
Our costs and the timing of our performance under
grants and contracts are also affected by trends in the US labor market, particularly, recruiting of scientists and technicians. We are
currently onboarding three new employees and expect to continue to hire in the next three quarters. We had observed some limited availability
in this market, but in early 2023, this has improved, and we anticipate being able to locate and retain the necessary personnel for the
foreseeable future.
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. At December 31, 2022, the company had total current assets of $6,086,231 and total current liabilities
of $756,532, resulting in working capital surplus of $5,329,699. At December 31, 2022, we had $5,640,308 of cash and cash equivalents,
an increase of $1,977,693 from $3,662,615 at December 31, 2021.
During the year ended December
31, 2022, the net cash outflow from operating activities was $3,929,837. This amount was comprised primarily of our net loss of $5,771,642.
This was offset by non-cash stock-based compensation expense of $1,776,140, amortization of future compensation payable of $416,666, amortization
of prepaid assets of $221,352, loss on disposal of equipment of $14,540, depreciation and amortization expense of $73,519, and the amortization
of right of use assets of $112,613. Additionally, net cash used from changes in assets and liabilities totaled $773,025. This included
an increase in accounts receivable $353,149, increase in prepaid and deposits of $270,735, a decrease in accounts payable of $78,412 and
a decrease in operating lease liabilities of $76,288. This is offset by an increase in accrued expenses and compensation of $5,499.
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During the year ended December
31, 2022, the net cash outflow from investing activities was $74,184. This was for the acquisition of equipment.
During the year ended December 31, 2022, net cash flows from financing
activities were $5,981,709. This amount consisted of $175,435 in proceeds on a note payable for insurance premium financing, $19,069 from
the exercise of options, and $6,586,198 in proceeds from the issuance and sale of 2,993,727 shares of common stock, to investors in a
private placement under Section 4(a)(2) of the Securities Act of 1933, as amended, which was offset by $798,988 in conjunction with the
monthly repayment of the note for the company’s insurance premium financing and AOS note. The proceeds from a subscription payable
represent funding received as part of a pending private placement of equity.
On April 28, 2020, AE 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, AE was able to keep all employees fully engaged during these two months of the pandemic. Accordingly,
on July 2, 2021, we received a letter from our bank, via the SBA, approving conversion of $80,593.55 of the loan to a grant. Between
January and April 2022, the company fully repaid the balance of the loan in four monthly installments at the 1% annual interest rate
and no amounts remain outstanding.
Based on the company’s
current business plan, we believe our cash balance as of the date of this report, along with anticipated revenues from our recently received
ONR grant and STTR agreement, will be sufficient to meet the company’s anticipated cash requirements for the near term. However,
there can be no assurance that the current business plan will be achievable.
The company’s existence
is dependent upon management’s ability to develop profitable operations. Management is devoting a significant portion of its efforts
to developing additional business and raising capital, as needed, but cannot be certain that these efforts will be successful. Management’s
business development efforts may not result in profitable operations. To fund its research and development and marketing efforts, the
company’s management continues to explore possible financing opportunities through discussions with investment bankers and private
investors. The company may not be successful in its effort to secure additional financing on terms it considers favorable. The accompanying
consolidated financial statements do not include any adjustments that might result should the company be unable to continue as a going
concern.
Additionally, the Russian
military action in Ukraine and related economic sanctions around the globe could impact the company’s ability to source necessary
supplies and equipment which could materially and adversely affect its ability to continue as a going concern. In addition, the company’s
ability to continue as a going concern may depend on its ability to raise capital which may be impacted by these events, including as
a result of increased market volatility, or decreased market liquidity. This may result in third-party financing being unavailable on
terms acceptable to the company or at all. The impact of this action and related sanctions on the world economy and the specific impact
on the company’s financial position and results of operations are not yet determinable. The financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
Budgeting for upcoming expenses and costs of supplies and equipment
needed to perform our ONR grant, described under “Recent Developments” above, and any other contracts or grants we receive
in the future, requires that we estimate factors such as inflation and geo-political events that affect such expenses and costs. The cost
of labor continues to increase across many sectors of the US and global economy which is likely to drive up our general and administrative
expenses as well as the cost of personnel working directly and indirectly on our grants and contracts. This aspect of inflation is particularly
difficult given the highly skilled nature of this work. Inflation is also likely to impact the price of supplies and materials we must
purchase in order to perform grants and contracts, some of which may have been bid on based on cost structures which were submitted during
periods of lower inflation. In addition, the war in Ukraine and other related geo-political events have further limited the number of
countries from which we can source certain supplies and equipment. These limitations can range from outright prohibitions to strong discouragement
based on potentially sensitive information. We continually monitor these events and the markets for needed supplies in order to make the
best estimates possible, both in our internal budgeting and in any bids or proposals we submit.
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Contractual Obligations:
The following table summarize
our contractual obligations and other commercial commitments as of December 31, 2022:
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 an 11,000 usable square foot (13,000 rentable 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.
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, 2022, and March 11, 2023, were approximately $322,000 and $338,000,
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 $331,549 as of December 31, 2022, 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, 2022, there were 13,602 shares of Series A Preferred Stock outstanding.
Recent Accounting Pronouncements:
Refer to Note 3 of Notes
to Consolidated Financial Statements for a discussion of recent accounting standards and pronouncements.
Off-Balance Sheet Arrangement:
As of December 31, 2022,
we had no significant off-balance sheet arrangements.
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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’
2022 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
Our management, with the
participation of our Chief Executive Officer and Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures
as of December 31, 2022. 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, 2022.
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:
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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 Financial Officer (“CFO”), has conducted an assessment of the effectiveness of our internal control over financial
reporting as of December 31, 2022, 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 CFO has concluded that our internal control over financial reporting was not effective
as of December 31, 2022.
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, 2022, 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 officer and directors:
Name Age Principal Position Director, Term expiring in
Bradford T. Adamcyzk 54 Director and Executive Chairman 2.5 years
Gregory J. Quarles 61 Director, President and Chief Executive Officer 2.5 years
Christopher, Donaghey 50 Chief Financial Officer N/A
Jonathan R. Barcklow 39 Director, Vice President, and Secretary* 1.5 years
John E. Schultz Jr. 69 Director Less than one year
Stephen W. McCahon 63 Chief Scientist and Consultant N/A
* Mr. Barcklow served as
Vice President and Secretary until September 8, 2022, upon which Ms. O’Hara assumed the office of Secretary, and the board
determined to eliminate the position of Vice President.
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.
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. Additionally,
Mr. Adamczyk helped drive the initial recapitalization efforts of Applied Energetics in 2018. He was part of the team that led the 2018
proxy of AE, establishing a new company board and management team and recapitalizing the company to pursue the development of its technology
and IP portfolio. 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 Optica (formerly, The Optical Society
of America) 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 Optica encompassed a broad range of scientific, technical and engineering infrastructure, and included content
development for the Optica meetings portfolio, along with many other related projects, highlighted by his reports to Congress. Moreover,
Dr. Quarles had been personally involved through Optica 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 35 years of experience since the award of his Ph.D. from Oklahoma
State University. He is a Fellow in both the SPIE and Optica, a Senior Member of the IEEE 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.
Christopher Donaghey:
Mr. Donaghey is an experienced financial executive with extensive experience in the defense industry. Mr. Donaghey most recently
served as senior vice president and head of corporate development for Science Applications International Corporation (SAIC), a defense
and government agency technology integrator, where he was responsible for executing the company’s mergers and acquisitions (M&A)
and strategic ventures strategy. He joined SAIC in 2017, as senior vice president of finance for SAIC’s operations. Mr. Donaghey
is also a Founder and Executive Board member of the Silicon Valley Defense Group, a non-profit organization whose mission is to create
the nexus of pioneering ideas, people, and capital that will unlock new sources of innovation for national security and power the digital
evolution of the defense industrial base. Prior to joining SAIC, Donaghey was Vice President of Corporate Strategy and Development for
KeyW Corporation, a national security solutions provider for the intelligence, cyber and counterterrorism communities, where he guided
the overall corporate strategy, M&A, and capital markets activities. Mr. Donaghey was also a senior research analyst for SunTrust
Robinson Humphrey Capital Markets during which time, he was ranked the number one defense analyst and number two analyst overall for
stock selection by Forbes/Starmine in 2005 and was named in the Wall Street Journal Best on the Street survey in 2005, 2008, and 2009.
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Mr. Donaghey served in the
U.S. Navy Reserve where he provided scientific and technical analysis of missile guidance and control systems and advanced electronics
for the Short-Range Ballistic Missile group at the Defense Intelligence Agency’s Missile and Space Intelligence Center. Donaghey
earned his bachelor’s degree in mechanical engineering from Texas Tech University and served as an officer in the U.S. Navy. Mr.
Donaghey served on Applied Energetics’ Board of Advisors from April 30, 2019 until becoming Chief Operating and Financial Officer.
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.
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. Additionally, Mr. Schultz helped drive the initial recapitalization efforts
of Applied Energetics in 2018. He was part of the team that led the 2018 proxy of AE, establishing a new company board and management
team and recapitalizing the company to pursue the development of its technology and IP portfolio. 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. Ms. O’Hara was appointed General Counsel and Chief
Legal Officer in January 2022 and Secretary in September 2022. She has been in private law practice for over thirty years and has broad
experience in all facets of securities, corporate and commercial law. Prior to her joining the company full time, she was 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 a 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.
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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:
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. Based on a review of these filings, the initial Form 3 for the company’s
Chief Financial Officer and a Form 4 reporting a change in ownership for Mr. Schultz, one of the company’s directors, were filed
after their respective deadlines. The company does not believe any other officers or directors failed to timely file any required forms
under Section 16(a) during the year ended December 31, 2022.
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 and Chief 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: Chief Legal 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 Executive Chairman, President and Chief Executive Officer, Chief Financial Officer, General Counsel, Chief Legal Officer
and Secretary, and Chief Scientist for the years ended December 31, 2022 and 2021. Mr. Quarles has been our Chief Executive Officer from
May 6, 2019 to present and was elected President as of January 2022. Ms. O’Hara was appointed General Counsel and Chief Legal Officer
in January 2022 and Secretary in September 2022. She and Mr. Adamczyk receive compensation as directors as set forth under Director Compensation
below.
Bradford T. Adamczyk, 2022 $ - $ - $ - - $ - $ -
Executive Chairman 2021 $ - $ - $ - - $ - $ -
General Counsel, CLO and Secretary 2021 - $ - $ - - $ - -
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Director Compensation
The following table discloses
our director compensation for the years ended December 31, 2022 and 2021:
Mary P. O’Hara, 2022 $ - $ - $ - $ - $ -
Board Considerations in Determining Salaries
Our executive compensation program is designed to attract, retain,
and incentivize talented executives with a dedication to achieving our scientific and strategic objectives. Our 2022 compensation program
consisted primarily of base salary and equity awards. Compensation of our named executive officers is primarily determined by compensation
levels in the market for their services, among large- and small-cap defense and technology companies. The Board considers recommendations
from various outside consultants and other informed sources in making compensation decisions. Aligning executive compensation with stockholder
interests is a key consideration for our compensation program. As we continue to grow, we anticipate developing and evolving our compensation
program around specific objectives and key responsibilities with metrics and compensation targets.
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Employment Agreements for Named Executive
Officers, General Counsel 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, on November 30,
2021, increasing his salary to $350,000 per year effective January 1, 2022, and again, on November 29, 2022, increasing his
salary to $400,000 per year effective November 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.
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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. Effective May 23, 2022, the company and
Dr. McCahon agreed to an extension of the SWM Consulting Agreement upon the same general terms and conditions. On January 17, 2023, the
company amended the SWM Consulting Agreement, pursuant to which Stephen W. McCahon serves as its Chief Scientist. The amendment is effective
January 1, 2023, provides for an extended term of three years, commencing on that date, and increases compensation under the agreement
to $300,000, $325,000 and $350,000 per year for the first, second and third years of the extended term, respectively.
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. Effective May 2022, the parties further amended the Promissory Note to extend the maturity date by an additional
six months and to further restructure the remaining payments due thereunder to be smaller and monthly, rather than semi-annually. As
of December 31, 2022, $400,000 in principle remained due under the Promissory Note.
Effective January 1,
2022, the company and Mary P. O’Hara entered into an Executive Employment Agreement, pursuant to which she is currently serving
as General Counsel and Chief Legal Officer for an initial term of three years, with automatic renewal for additional one-year periods
thereafter unless either party terminates the agreement. The agreement calls for salary of $250,000 per year, plus standard benefits and
eligibility for a bonus at the discretion of the board. The company has also granted Ms. O’Hara incentive stock options to purchase
up to 640,000 shares of its common stock under its 2018 Incentive Stock Plan, which vest over four years, at an exercise price
of $2.40 per share.
Effective August 1, 2022,
the company and Christopher Donaghey entered into an Executive Employment Agreement, pursuant to which he is to serve as Chief Financial
and Chief Operating Officer for an initial term of four years, with automatic renewal for additional one-year periods thereafter
unless either party terminates the agreement. The agreement calls for salary of $350,000 per year, plus standard benefits and eligibility
for a bonus at the discretion of the board. The company has also granted Mr. Donaghey additional options to purchase up to 1,000,000 shares
of its common stock under its 2018 Incentive Stock Plan, which vest over four years and have an exercise price of $2.36 per share,
and Restricted Stock Units representing up to 400,000 shares of the company’s common stock which also vest over four years.
The Restricted Stock Units are issued pursuant to a Restricted Stock Unit Agreement, dated as of July 13, 2022. Mr. Donaghey