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 ("USP™") 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.
18
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:
2022 2021
Revenue $ 1,307,757 $ -
Cost of revenue 305,675 -
Gross Profit 1,002,082 -
Operating expenses:
General and administrative 6,129,781 4,903,081
Selling and marketing 321,384 317,350
Research and development 320,506 281,896
Total operating expenses 6,771,671 5,502,327
Other income/(expenses):
Other income 1,674 81,218
Interest (expense) (3,727 ) (4,344 )
Other income/(expense) (2,053 ) 76,874
Loss before provision of income taxes (5,771,642 ) (5,425,453 )
Provision for income taxes - -
Net loss $ (5,771,642 ) $ (5,425,453 )
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.
21
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
Notes payable $ 400,000 $ 400,000 $ -
Due to affiliate 50,000 50,000 -
Leases 507,000 143,000 364,000
Total $ 957,000 $ 593,000 $ 364,000The 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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