ITEM 7. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You
should read the following discussion and analysis 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, 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, Christopher Donaghey as our Chief Operating and Financial Officer, and
Dr. Stephen W. McCahon as our Chief Science Officer. 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 2023 and into early 2024, with the addition of six new employees, including a senior scientist,
two laser technicians, one engineering project manager, a senior advisor, and, most recently, a director of new product innovation. AE
also works with a team of world-class contractors to strengthen our compliance, IT, technical staff, human resources and public relations,
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 25 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 nine 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.
Following
successful completion of work on the STTR Phase I contract with the U.S. Army and the research grant by the U.S. Marine Corps in 2022,
AE was awarded additional contracts in 2023, and payments due for the final deliverables under the Marine Corp grant have been transferred
to a new contract executed during the first quarter of 2024, all as detailed below.
Effective
March 12, 2024, a grant previously awarded to Applied Energetics, Inc. from a U.S. Department of Defense customer has been transitioned
into a contract. The original grant had a two-year period of performance. The new contract supersedes the May 2022 grant and carries a
ceiling value of $1,217,535 under a base period of performance through November 11, 2024 and a 12-month unfunded option period that ends
November 11, 2025. The company intends to provide additional information in a Current Report on Form 8-K upon approval from the government
agency.
Effective
August 23, 2023, Applied Energetics executed a contract with the Department of the Navy, Office of Naval Research with an aggregate contract
price of $1.99 million payable over two years as the company performs its obligations under the contract. The objective of the contract
is to develop a high-peak and high-average power USP optical system. The system is expected to demonstrate effects compatible with multiple
Navy platforms and missions with an attractive size, weight, and power-cooling footprint. The company’s continuing development
efforts in collaboration with ONR signify the importance of sustained development and maturation of USP-based directed energy systems
to support the Navy’s technological priorities.
Effective
May 15, 2023, Applied Energetics executed a Phase II Small Business Technology Transfer (STTR) contract with the U.S. Army at an aggregate
contract price of $1.148 million payable over two years as the company performs its obligations thereunder, with the first year currently
funded. The objective of this Phase II award is to further the development and testing of an IR system utilizing technologies that were
investigated under the US Army Phase I STTR contract which the company was awarded in May 2022. This Phase II contract award follows
a successful Phase I which established a computational concept with physical modeling and simulation to establish the feasibility of
an IR system. Phase I was performed in collaboration with the James C. Wyant College of Optical Sciences at the University of Arizona.
The company has continued its work under the contract, and provided all required reports, since its execution.
AE’s team continues to be invited to, and complete, multiple briefings focused on our capabilities and our submissions and to submit
contract proposals. Following the closures of government agencies during the Covid -19 pandemic, the government has been reviewing and
processing proposals and holding in-person meetings for briefings where appropriate. However, this positive action by the agencies could
be reversed in the event of a resurgence of Covid or other national health emergency. 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.
Neither of the US federal budgets for 2023 or 2024 were approved by
Congress by the start of the corresponding U.S. federal government fiscal year, which is October 1 of the preceding year. In both 2022
and 2023, Congress passed, and the president signed, continuing resolutions (“CRs”), to extend federal government funding.
specified dates. The final Defense Appropriations Bill for fiscal 2023 was signed into law on December 29, 2022 and included increases
in areas of particular interest to the company.
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For fiscal year 2024, which started on October 1, 2023, the National
Defense Authorization Act (NDAA) was delayed and finally approved on December 22, 2023 (HR 2670), but the Defense Appropriations bill
was not approved at that time. The NDAA sets defense spending policies, and the appropriations bills fund government spending. This impacts
all proposals under review by the Department of Defense. On September 30, 2023, President Biden signed a Continuing Resolution (CR), HR
5860, which extended the government operations through November 17, 2023, and he then signed three further CRs, including HR 6363 on November
11, 2023 extending through January 19, 2024, HR 2872 extending through March 1, 2024, and HR 7463, extending through March 8, 2024, as
to four of the 12 annual budget bills, and through March 22, 2024 for the remaining eight. On March 23, 2024, the Defense Appropriations
Bill was passed and signed by President Biden which will ensure the US government is funded through September 30, 2024 and that new government
contracts can be funded during the 2024 fiscal year. Delays and uncertainty around funding may delay allocation of funds or pose a payment
risk for the company with respect to any grants or agreements under which we are already working.
Strategic Plan and
Analysis
The
core of our strategy has been to continue growing our management and science teams with highly qualified individuals. This has driven
our recruitment efforts in the areas of R&D, science, modeling and simulation, marketing and finance. We are also contemplating adding
members to our Board of Directors and our Board of Advisors. Our board and leadership team 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. The company’s management continues to explore any favorable equity financing opportunities.
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 has been 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.
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 several years, we continued to submit proposals and have been engaged
in meetings on a continuous 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 several contracts since 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 reach $17.8 billion globally by 2028. 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. We believe that once
these technologies are funded in production for a POR, these DOD budgets for directed energy 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 the USP marketplace.
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Our
research and development programs depend on our ability to procure the necessary optical and fabricated materials, components, electronics
and other supplies. A significant, prolonged increase in inflation could negatively impact the cost of materials and components, which
could be a particular problem with respect to our fixed fee contracts. Within the current geopolitical context, there are ongoing embargos
of exports from some global suppliers of various materials that are used in electronics and some diode and laser materials, which can
have negative effects on technology supply chains. We continuously monitor potential supply chain issues and supplier liquidity and work
with our supply base to ensure adequate sources of materials at reasonable costs. In some instances, we depend upon a single source of
supply, but we are developing multiple sources where possible to mitigate the risk. In some cases, we must comply with specific procurement
requirements, which can limit the suppliers and subcontractors we may utilize.
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 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.
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Results of Operations
Our
consolidated financial information for the years ending December 31, 2023 and 2022 is as follows:
Operating expenses:
Other income/(expenses):
Interest (expense) - (3,727 )
Provision for income taxes - -
Revenue
Revenue
increased by approximately $1,323,000, or 101%, to approximately $2,631,000 for the year ended December 31, 2023, from $1,308,000 for
the year ended December 31, 2022. The increase represents two additional contracts that we received and commenced performing in May 2023
and August 2023.
Cost of Revenue
Cost
of revenue increased by approximately $332,000, or 109%, to approximately $638,000 for year ended December 31, 2023, from $306,000 during
the year ended December 31, 2022. This represents costs directly associated with the grant that the company commenced in June 2022 and
the additional contracts that were commenced in May 2023 and August 2023.
General and Administrative
General
and administrative expenses increased approximately $2,642,000, or 43%, to $8,772,000 for the year ended December 31, 2023, compared to
approximately $6,130,000 for the year ended December 31, 2022, primarily due to a decrease of approximately $20,000 in insurance expenses,
an increase in salaries and employee benefits of approximately $1,050,000, in consulting for stock-based comp $1,224,000, in depreciation
expense of approximately $54,000, in rent $135,000, and in legal of $198,000.
Selling and Marketing
Selling
and Marketing expenses increased approximately $63,000, or 20%, to $384,000 for the year ended December 31, 2023, compared to approximately
$321,000 for the year ended December 31, 2022, 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.
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Research and Development
Research
and development expenses decreased approximately $87,000, or 27%, to $234,000 for the year ended December 31, 2023, compared to approximately
$321,000 for the year ended December 31, 2022, primarily due to transitioning personnel from research and development to commercialization
activities due to additional contracts awarding during the year. This transition is reflected in a portion of the increase in cost of
revenue.
Other Income/(Expense)
Other
income increased approximately $48,000, or 2,400%, to $46,000 for the year ended December 31, 2023, compared to other expenses of $2,000
for the year ended December 31, 2022, primarily due to holding cash in short-term money market funds with Franklin Templeton Institutional
Services.
Net Loss
Our
operations in 2023 resulted in a net loss of approximately $7,350,000, an increase of approximately $1,578,000, or 27%, compared to the
approximately $5,772,000 net loss for the year ended 2022, primarily due to increases in general and administrative and selling and marketing
expense, partially offset by higher revenue and a decrease in research and development expenses.
Trend Discussion
During
the year ended December 31, 2023, as we received our ONR contract and a Phase II STTR contract with the Army, we recognized revenues
as we performed these services and also recorded related costs. Costs under these contracts continue to be affected by ongoing supply
chain disruptions, and shortages of items like semiconductor chips, and related systemic issues, and general inflation although to a
lesser extent than in 2022. 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. Certain optical transmitting components
are also in short supply. 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 continue to be affected by trends in the US labor market, particularly,
recruiting of scientists and technicians. We had observed some limited availability in this market in 2022 with some improvement in 2023,
and we anticipate being able to locate and retain the necessary personnel for the foreseeable future.
Liquidity and Capital
Resources
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, 2023, the company had total current assets of $2,035,656 and total current
liabilities of $927,382, resulting in a working capital surplus of $1,108,274. At December 31, 2023, we had $1,319,526 of cash and cash
equivalents, a decrease of $4,320,782 from $5,640,308 at December 31, 2022.
During
the year ended December 31, 2023, the net cash outflow from operating activities was $3,450,653. This amount was comprised primarily
of our net loss of $7,350,435. This was offset by non-cash stock-based compensation expense of $3,493,397, amortization of prepaid assets
of $202,354, depreciation and amortization expense of $127,639, and the amortization of right of use assets of $143,602. Additionally,
net cash used from changes in assets and liabilities totaled $67,210. This included an increase in accounts receivable $214,643, increase
in prepaid and deposits of $257,918, and a decrease in operating lease liabilities of $112,050. This is offset by an increase in accounts
payable of $195,988, an increase in deferred revenue of $308,908 and accrued expenses and compensation of $12,505.
During
the year ended December 31, 2023, the net cash outflow from investing activities was $369,267. This was for the purchase of equipment.
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During
the year ended December 31, 2023, net cash outflow from financing activities was $500,862, which consisted mainly of repayment of our
note payable of $555,541, payment of $136,671 to the IRS for tax withholding related to the share settlement of RSUs issued to employees,
offset by $155,541 in proceeds from note payable for insurance premium financing and $35,809 in proceeds from the exercise of options.
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 contract anticipated contract revenue, will be sufficient to meet the company’s anticipated cash requirements for the
near term. However, we cannot be certain that the current business plan will be achievable.
The
company’s existence depends 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,
international, macroeconomic events, including 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 our ability
to continue as a going concern. These events may also impair our ability to raise capital, including as a result of increased market
volatility, or decreased market liquidity, which also affects the company’s ability to continue as a going concern. Third-party
financing may become unavailable on terms acceptable to the company or at all. The impact of such events on the world economy and the
specific impact on the company’s financial position and results of operations are difficult to predict. 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 existing, and any future, grants or contracts requires
that we estimate factors such as inflation and geo-political events that affect such expenses and costs. Although inflation generally
moderated in 2023, the cost of labor continues to increase across certain sectors of the US and global economy which may drive up our
general and administrative expenses as well as the cost of personnel working directly and indirectly on our grants and contracts, particularly
given the highly skilled nature of this work. Inflation has also impacted 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, 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.
Contractual Obligations:
The following table summarize
our contractual obligations and other commercial commitments as of December 31, 2023:
Payment by Period
Total Less than 1 Year 1 to 5 Years
Notes payable $ - $ - $ -
23
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.
On
June 7, 2023, the company entered into an amendment to extend the term of the original lease from April 26, 2026 to July 31, 2028. Included
in the lease amendment is extension space commencing on August 1, 2023. As of August 1, 2023, the company has secured additional square
footage in the amount of 9,805 square feet. The initial base rent for the expansion space was $9.10 per rentable square foot for year
one, and escalated to $10.20 in year two, $11.30 in year three, $12.40 in year four and $13.50 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, 2023, and March 25, 2024, were approximately $363,000 and $373,000, 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 $363,000 as of December 31, 2023, 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, 2023, 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, 2023, 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 and money market funds. 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.
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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’ 2023 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, 2023. 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, 2023.
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.
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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, 2023, 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. This assessment also took into consideration a material weakness cited by our auditors. In
particular, our auditors noted lack of segregation of duties and written policies and procedures with the accounting functions and
evidence of control review in that we have not designed such policies and procedures at a sufficient level to support the operating
effectiveness of controls to prevent and detect potential error. To mitigate this weakness, our auditors suggested that the company
continue to maintain sufficient accounting personnel to ensure segregation of duties and accurate accounting records, noting that we
use an outside consultant to perform day-to-day review function and that we create, document and maintain policies and procedures.
Our management intends to take this guidance into consideration as we work to resolve this weakness. 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, 2023.
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’s attestation in an 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, 2023, that
materially affected, or is reasonably likely to materially affect our internal control over financial reporting.
ITEM 9B. OTHER INFORMATION
Rule 10b5-1 Trading Arrangements
During the year ended
December 31, 2023, certain of our officers and directors adopted Rule 10b5-1 trading arrangements as follows:
On June 12, 2023, Bradford
T. Adamczyk, Executive Chairman, adopted a written plan intended to satisfy the affirmative defense of Rule 10b5-1(c) that took effect
on September 15, 2023, and is designed to be in effect until July 15, 2024, with respect to the sale of up to 1,400,000 shares of the
company’s common stock all of which underlie stock options held by Mr. Adamczyk. Through March 21, 2024, Mr. Adamczyk has sold 70,000 shares under the plan, consisting of 0.9% of shares he beneficially
owns.
On June 12, 2023, Adamczyk
Family 2021 LLC (the “Adamczyk LLC”), an entity controlled by Bradford T. Adamczyk, the company’s Executive Chairman,
adopted a written plan intended to satisfy the affirmative defense of Rule 10b5-1(c) that took effect on September 15, 2023, and is designed
to be in effect until July 15, 2024 with respect to the sale of up to 800,000 shares of the company’s common stock all of which
underlie stock options earned by Mr. Adamczyk for services to the company and held by the Adamczyk LLC. No shares have been sold under this plan as of March 21, 2024.
On June 15, 2023, Gregory
J. Quarles, President and Chief Executive Officer, adopted a written plan intended to satisfy the affirmative defense of Rule 10b5-1(c)
that took effect on September 21, 2023, and is designed to be in effect until July 15, 2024 with respect to the sale of up to 1,300,000
shares of the company’s common stock all of which underlie stock options held by Dr. Quarles. Through March 21, 2024, Mr. Quarles has sold 50,000 shares under the
plan, consisting of 0.7% of shares he beneficially owns.
On June 14, 2023, Mary
P. O’Hara, General Counsel, Chief Legal Officer, and Secretary adopted a written plan intended to satisfy the affirmative defense
of Rule 10b5-1(c) that took effect on September 21, 2023, and is designed to be in effect until July 15, 2024 with respect to the sale
of up to 550,000 shares of the company’s common stock all of which underlie stock options held by Ms. O’Hara. No shares have been sold under this plan as of March 21, 2024.
On
June 15, 2023, Stephen W. McCahon, Chief Science Officer, adopted a written plan intended to satisfy the affirmative defense of Rule
10b5-1(c) that took effect on September 15, 2023, and is designed to be in effect until March 14, 2024 with respect to the sale of
up to 2,100,000 shares of the company’s common stock held by Dr. McCahon. The plan expired in accordance with its terms on
March 14, 2024. No shares were sold under this plan.
ITEM 9C. DISCLOSURE
REGARDING FOREIGN JURISDICTIONS THAT PREVENT INSPECTIONS.
Not
applicable
26
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 55 Director and Executive Chairman 2.5 years
Gregory J. Quarles 62 Director, President and Chief Executive Officer 2.5 years
Christopher, Donaghey 51 Chief Financial Officer N/A
Jonathan R. Barcklow 40 Director 1.5 years
John E. Schultz Jr. 70 Director Less than one year
Stephen W. McCahon 64 Chief Science Officer 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. On March 25, 2024, Mr. Barcklow tendered his resignation from the board, effective April 1, 2024. The company
accepted Mr. Barcklow’s resignation which was not in connection with any disagreement regarding company policies or other dispute.
Bradford
T. Adamczyk: Mr. Adamczyk was elected as the company’s Chairman in May 2019 and Executive Chairman in November 2021. 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. 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, and his MBA from the University of Michigan.
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.
27
Christopher
Donaghey: Mr. Donaghey has served as the company’s Chief Operating and Financial Officer since July 2022. He 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.
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 served as the company’s Vice President and Secretary from November 2018 until September 2022,
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.
28
Stephen
W. McCahon: Dr. Stephen McCahon has served as the Company’s Chief Science Officer since May 1, 2023. 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 an original founder of Applied Energetics, Inc. and then returned to the Company to serve as our Chief Scientist,
pursuant to a Consulting Agreement, dated as of May 24, 2019, providing input into the strategic direction of the Company and
assistance in building relationships in the defense markets. Dr. McCahon 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
(LGE® 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. From February 2016 through May 2019, he served as a consultant to the Company. 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. 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.
Newly Elected Director
On
March 25, 2024, our Board of Directors voted by Unanimous Written Consent to elect Michael J. Alber to serve as a director. Mr. Alber’s
term is to commence on April 1, 2024.
Mr.
Alber has an extensive career spanning over 35 years in corporate finance, capital markets, treasury, risk allocation and mergers and
acquisition experience. Most recently he was the Chief Financial Officer for First Light Acquisition Group (NYSE: FLAG), a special purpose
acquisition company. He previously served on the SSA (Special Security Agreement) of AceInfo Tech (subsidiary of Dovel Technologies)
and advisory board of Sincerus Global Solutions. Prior to 2020 he was the Chief Financial Officer and Executive Vice President of KeyW
(NASDAQ: KEYW) from June 13, 2016, until its sale to Jacobs (NYSE: J) in 2019. During this period, he led several capital market transactions
along with two strategically important M&A transactions, one that resulted in a record setting sale multiple and change in control.
Mr.
Alber served as a Principal with Growth Strategy Leaders, a business and financial consulting firm (specializing in M&A and due diligence
support), from April 2015 to May 2016, and as Chief Financial Officer and SVP at Engility Corporation (NYSE: EGL) a $2.5 billion technology
services and solutions provider to both U.S. Government and International customers from May 2012 to March 2015. During this period,
he supported the company’s spin-out from L3 Technologies as a stand-alone publicly traded company. Also, during this period, he
led the financial and capital market activities related to two transformational M&A transactions, including one that resulted in
a change in control. Prior to Engility, Mr. Alber held the position of Chief Financial Officer and Treasurer at Alion Science and Technology
from 2007 to 2012. He has also held senior executive positions at SAIC (NYSE: SAIC) for 18 years, where he served as a Senior Vice President
and Group CFO, and prior to that was Director of Finance at Network Solutions, Inc.
Mr.
Alber received his Bachelor of Science degree from George Mason University in Business Administration with a concentration in finance
and subsequently completed an Advance Management Program (AMP) at Georgetown University’s McDonough School of Business.
As
compensation for his services on the Board, the company intends to issue to Mr. Alber options to purchase up to 250,000 shares of its
common stock at an exercise price equal to the fair market value on the date of grant. These options will be subject to vesting in the
amount of 100,000 shares on the first anniversary of his service and 75,000 on each of the second and third anniversaries of his service
and to further terms and conditions as set forth in a Nonqualified Stock Option Agreement to be entered into between the company and
Mr. Alber under the company’s 2018 Equity Incentive Plan. Mr. Alber has not entered into any related party transactions with the company.
29
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 have 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
Board of Directors focuses 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 and a Form 4 for the company’s Chief Science Officer and a Form 4 reporting a change in ownership for our Chief Financial
Officer, 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, 2023.
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