Applied Energetics, Inc.: Form 10-Q for the period ended Jun 30, 2023

Our discussion and analysis of the financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related disclosures included elsewhere herein and in the Management’s Discussion and Analysis of Financial Condition and Results of Operations included as part of our Annual Report on Form 10-K for the year ended December 31, 2022 and Quarterly Report on Form 10-Q for the three and six months ended June 30, 2023.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the securities laws. Forward-looking statements include all statements that do not relate solely to the historical or current facts and can be identified by the use of forward-looking words such as “may,” “believe,” “will,” “would,” “could,” “should,” “expect,” “project,” “anticipate,” “estimates,” “possible,” “plan,” “strategy,” “target,” “prospect,” or “continue,” and other similar terms and phrases. These forward-looking statements are based on the current plans and expectations of our management and are subject to a number of uncertainties and risks that could significantly affect our current plans and expectations, as well as future results of operations and financial condition and may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Important factors that could cause our actual results to differ materially from our expectations are described in Item 1A (Risk Factors) of our Annual Report on Form 10-K, for the year ended December 31, 2022. Although we believe that the expectations reflected in such forward-looking statements are reasonable, there can be no assurance that such expectations will prove to have been correct. We do not assume any obligation to update these forward-looking statements to reflect actual results, changes in assumptions, or changes in other factors affecting such forward-looking statements.

Applied Energetics, Inc. ((sometimes referred to as the “company”) is a corporation organized and existing under the laws of the State of Delaware. Our executive office is located at 9070 S. Rita Road, Suite 1500, Tucson, Arizona 85747, (520) 628-7415. Our website is at www. appliedenergetics.com

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.

Technology, Capabilities and Patents

Applied Energetics, Inc. is recognized as a global leader in developing the next generation optical sources exhibiting ever-increasing output energy, peak power and frequency agility while also providing decreased size, weight, and cost of these systems for customers. Applied Energetics utilizes patented, dual-use technologies to advance critical industries. Leveraging our proprietary fiber-based architecture and wavelength- and pulse-agility capability, our Ultrashort Pulse (USP) technology can enable users to achieve specific effects across different use cases with an unmatched blend of size, weight and power attributes. While initially designed to meet the emerging needs and priorities for the national security community, our directed energy technology also has commercial applications in both the biomedical and advanced manufacturing industries.

The Applied Energetics scientific team is continuously innovating and expanding our patent portfolio to cover these technological breakthroughs and further enhance our suite of solutions for threat disruption for the Department of Defense, the intelligence community, and for commercial, biomedical and space applications with optical sources operating from the deep ultraviolet to the far infrared portions of the electromagnetic spectrum.

Applied Energetics has developed, successfully demonstrated and holds all crucial intellectual property rights to a dynamic directed energy technology called Laser Guided Energy (LGE®) and Laser Induced Plasma Channel (LIPC®). LGE and LIPC are technologies that can be used in a new generation of high-tech directed energy systems. The Department of Defense (DOD) previously recognized only two key types of Directed Energy Weapon (DEW) technologies, High Energy Lasers (HEL), and High-Power Microwave (HPM). Neither the HEL nor the HPM intellectual property portfolio is owned by a single entity. The DOD then designated a third DEW technology, LGE. Applied Energetics’ LGE and LIPC technologies are wholly owned by Applied Energetics and protected by one or more of Applied Energetics’ 25 issued patents and 11 Government Sensitive Patent Applications (GSPA). These GSPA’s are held under secrecy orders of the US government, providing the company with extended protection rights. The company also has nine pending patent applications. We continue to file patent applications as we deem appropriate to protect our intellectual property and enhance our competitive advantage.

Applied Energetics’ Directed Energy technologies are vastly different from conventional directed energy systems, i.e. HEL, and HPM. LGE uses Ultrashort Pulse (USP) laser technology to combine the speed and precision of lasers with the overwhelming impact on targeted threats with high-voltage electricity. A key element of LGE is its novel ability to offer selectable and tunable properties that can help protect non-combatants and combat zone infrastructure. Applied Energetics’ proprietary fiber-based architecture is a key differentiator for our most recent technology demonstrators. Compared with traditional continuous wave laser technologies with their larger footprints, AE’s architecture enables orders of magnitude size-weight-power reductions on all deliverables, creating powerful, dual-use and agile systems that can fit a host of platforms while delivering very high-intensity, ultrashort pulses of light to the required target. This unique directed energy solution allows extremely high peak power and energy, with target and effects tunability, and is effective against a wide variety of potential targets.

Applied Energetics’ unique optical fiber-based laser architectures enable unmatched wavelength agility as well as pulse duration agility. Using innovative and highly specialized frequency shifting techniques, wavelengths can be custom tuned from the deep ultraviolet to the far infrared. In addition, temporal outputs can be adjusted from continuous wave to sub-picoseconds. The technology enables the customer to adjust the lasers’ operating parameters, ultimately creating more flexibility to change wavelength and pulse width. This feature allows for optimization of laser performance for defense or commercial applications.

Our proprietary USP laser technology provides a significantly more compact solution than current continuous wave laser platforms while still delivering high peak power. Continuous wave laser systems are typically used to heat a target and, during continuous illumination, this heat transfer leads to melting or charring of the material. Using continuous wave output powers that now exceed 100 kilowatts (1kW = 1000 watts), it can take anywhere from seconds to minutes to impact a target. By contrast, Applied Energetics has delivered USP lasers to national security users that exceed five terawatts (1 TW = 1 trillion watts) in peak power, with the difference being that this peak power from a USP laser is delivered in a pulse that is less than a trillionth of a second. During this short pulse duration, and having such a high peak intensity, near-instantaneous ablation of the surface of the threat takes place. The net results of our innovative USP approaches are highly effective lasers with mountable footprints that require only a fraction of the size and weight of other-directed energy technologies.

As Applied Energetics looks toward the future, our corporate strategic roadmap builds upon the significant value of the company’s USP laser capabilities and key intellectual property, including LGE and LIPC, to offer our prospective partners, co-developers and system integrators a variety of next-generation ultrashort pulse and frequency-agile optical sources, from the ultraviolet to the far infrared portion of the electromagnetic spectrum, to address numerous challenges within the national security, biomedical, and advanced manufacturing market sectors.

Recent Developments

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.

In May 2022, the Department of the Navy, Office of Naval Research (ONR) awarded Applied Energetics a $3.89 million, two-year grant, 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. The research on this grant continues with all progress reported to the program manager as on-time and on-budget. The AE team is actively engaged with the customer and providing regular briefings.

Effective June 7, 2023, the company entered into the First Amendment to Lease Agreement, which amended its existing Lease Agreement over its headquarters at the University of Arizona Tech Park. The amendment expands the Lease to add one new 8,374 usable square-foot suite of offices, conference rooms and cubicle areas directly across an atrium from the company’s current headquarters so that the company will occupy the entire first floor of the building. This is expected to enable the company to separate its public facing facilities from its restricted access space easily. The amendment also extends the Lease over the company’s existing headquarters through July 31, 2028 and grants the company an option over 5,520 usable square feet of manufacturing space. The company began setting up and moving its administrative offices into the new space at the beginning of August 2023.

During the first six months of 2023, Applied Energetics has continued to add new members to our scientific and engineering team, including two Laser and Optics Research and Development Technicians and an Engineering Project Manager. We also retained a Senior Growth and Product Development Advisor. We have worked to integrate these new members into our team and optimize the contribution that each brings to our research and development efforts.

Effective May 1, 2023, Stephen W. McCahon entered into an Executive Employment Agreement with the company to serve as Chief Science Officer (CSO). Dr. McCahon was an original co-founder of Applied Energetics, and in May of 2019, he returned to the company to serve as its Chief Scientist in a consulting role. Since that time, he has provided strategic direction to the company’s research and development activities in the areas of advanced optical technologies and USPL Directed Energy solutions. His salary as CSO is commensurate with his compensation under his Consulting Agreement for service as Chief Scientist.

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 Defense Department including very high energy and average power ultrashort pulse 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 ultrashort pulse laser development. Dr. McCahon is a graduate of the University of Southern California (BSEE, MSEE), holds a Ph.D., Photonics, Inter-disciplinary Physics and Electrical Engineering from the University of Iowa.

Dr. McCahon beneficially owns approximately 7% of the company’s issued and outstanding shares of common stock.

Applied Energetics has trademark applications pending before the USPTO for the marks AERGTM and AETM. The company also has nine pending patent applications. We continue to file patent applications as we deem appropriate to protect our intellectual property and enhance our competitive advantage.

Ongoing Business Development Activities

Over the past few years, we have submitted multiple proposals to, and attended briefings with, various defense and other government agencies who have expressed an interest in our technology and applications. Although we experienced setbacks due to the closures of multiple agencies and work-from-home orders during the COVID-19 pandemic, we believe that our efforts in this area of development have begun to produce results. In addition to the grant and contracts which we have been awarded, our team has been invited to, and completed, multiple briefings focused on our capabilities and submissions. We intend to continue developing and submitting proposals and to be available to attend on-site briefings. Although we do not anticipate a return of the closures or work-from-home orders in the near future, any changes to reinstate them could again hamper our ability to schedule on-site briefings.

Two significant pieces of legislation impacted Applied Energetics that were signed by the President on September 30, 2022. The first piece, bill S. 4900, the “SBIR and STTR Extension Act of 2022,” authorizes the Small Business Innovation Research (SBIR), Small Business Technology Transfer (STTR), and six related pilot programs through Fiscal Year 2025; requires agencies with an SBIR or STTR program to establish a due diligence program to assess the potential risk posed by program applicants’ foreign ties; requires certain departments and agencies to report on national security risks within their SBIR/STTR programs; and establishes increased minimum performance standards for firms that have won a certain number of awards during a specified period of time.

The other piece of legislation that we have seen multiple times in the past decade is the Continuing Resolution (CR), HR 6833, which was amended three times to provide fiscal year 2023 appropriations to federal agencies through December 30, 2022, for continuing projects and activities of the federal government and includes supplemental appropriations to respond to the Russian military action in Ukraine. This CR provided for a continuation of funding for currently funded programs through December 30, but no new contracts until the 2023 fiscal year appropriations was approved by Congress. This CR allowed for current Applied Energetics programs to continue. The Consolidated Appropriations Act, 2023 was passed by the US House of Representatives and the US Senate and signed by President Biden on December 29, 2022. A similar situation occurred in the prior year as the US government final fiscal year 2022 appropriations bill was signed into law by President Biden on the night of March 11, 2022 and included increases in areas of particular interest to the company.

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 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.

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 three 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 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 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. 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.

Results of Operations

Comparison of Operations for the Three Months Ended June 30, 2023 and 2022:

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Revenue

Revenue increased by approximately $369,000 to approximately $560,000, for the three months ended June 30, 2023, from approximately $191,000 for the three months ended June 30, 2022. Revenues for the 2022 period were from a contract and a grant that we received and commenced performing in June 2022. Revenues for the 2023 period were from continued work under the grant as well as a contract which the company signed in May 2023 and commenced performance in June 2023.

Cost of Revenue

Cost of revenue increased by approximately $162,000, or 1068%, to approximately $177,000, for the three months ended June 30, 2023, from approximately $15,000 for the three months ended June 30, 2022. This increase was primarily attributable to an increase in the cost of materials, supplies and direct labor cost incurred in connection with the increase revenues.

General and Administrative

General and administrative expenses increased approximately $579,000, or 39%, to approximately $2,067,000 for the three months ended June 30, 2023, compared to approximately $1,488,000 for the three months ended June 30, 2022, primarily due to an increase in salaries and employee benefits of approximately $446,000 mainly due to an increase in cash and non-cash compensation, an increase in travel and meals of approximately $17,000, an increase in software and licenses of approximately $14,000, an increase in depreciation expense of approximately $8,000, an increase of approximately $94,000 in consulting.

Selling and Marketing

Selling and marketing expenses decreased approximately $4,000, or 4%, to approximately $95,000 for the three months ended June 30, 2023, compared to approximately $98,000 for the three months ended June 30, 2022, primarily due to decrease in consulting fees incurred in connection with selling and marketing.

Research and Development

Research and development expenses decreased approximately $92,000, or 64%, to approximately $53,000 for the three months ended June 30, 2023, compared to approximately $145,000 for the three months ended June 30, 2022, primarily due to a decrease in labor costs associated with research and development activities.

Net Loss

As a result of the foregoing factors, our operations for the three months ended June 30, 2023, resulted in a net loss of approximately $1,818,000, an increase of approximately $261,000, or 17%, compared to the net loss of approximately $1,557,000 for the three months ended June 30, 2022.

Comparison of Operations for the six months ended June 30, 2023 and 2022:

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Revenue

Revenues increased by approximately $856,000, or 448%, to approximately $1,047,000 for the six months ended June 30, 2023, compared to approximately $191,000 for the six months ended June 30, 2022. Revenues for the 2022 period were from a contract and a grant that we received and commenced performing in June 2022. Revenues for the 2023 period were from continued work under the grant as well as a contract which the company signed in May 2023 and commenced performance in June 2023.

Cost of Revenue

Cost of revenue increased by approximately $303,000, or 1999%, to approximately $318,000, for the six months ended June 30, 2023, from approximately $15,000 for the six months ended June 30, 2022. This increase was primarily attributable to attributable to an increase in the cost of materials, supplies and direct labor cost incurred in connection with the increase revenues.

General and Administrative

General and administrative expenses increased approximately $1,065,000, or 34%, to approximately $4,182,000 for the six months ended June 30, 2023, compared to approximately $3,117,000 for the six months ended June 30, 2022, primarily due to an increase of approximately $73,000 in professional expenses, an increase in consulting expenses of approximately $104,000, an increase in salaries and employee benefits of approximately $734,000, an increase in travel and meals of approximately $49,000, an increase in depreciation expenses of approximately $26,000, an increase in software and license fees of approximately $33,000 and various other expenses of approximately $46,000.

Selling and Marketing

Selling and marketing expenses increased approximately $28,000, or 16%, to approximately $203,000 for the six months ended June 30, 2023, compared to approximately $175,000 for the six months ended June 30, 2022, primarily due to the continuation of business development activities as well as other consultants in this field.

Research and Development

Research and development expenses decreased approximately $108,000, or 49%, to approximately $113,000 for the six months ended June 30, 2023, compared to approximately $221,000 for the six months ended June 30, 2022, primarily due to a decrease in labor cost associated with research and development activities.

Net Loss

As a result of the foregoing, our operations for the six months ended June 30, 2023, resulted in a net loss of approximately $3,756,000, an increase of approximately $418,000 compared to the net loss of approximately $3,339,000 for the six months ended June 30, 2022.

Liquidity and Capital Resources

The accompanying unaudited condensed consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. For the six months ended June 30, 2023, the company incurred a net loss of approximately $3,756,000, had negative cash flows from operations of approximately $2,068,000 and may incur additional future losses as it works to secure government contracts and continues to incur the expenses discussed under Results of Operations. In their report accompanying our financial statements for the year ended December 31, 2022, our independent auditors stated that our financial statements were prepared assuming that we would continue as a going concern and that they have substantial doubt as to our ability to do so for one year from the date the financial statements are issued based on our recurring losses from operations and possible need to raise additional capital. The financial statements do not include any adjustments relating to the recoverability of assets and the amount or classification of liabilities that might be necessary should the company be unable to continue as a going concern.

At June 30, 2023, the company had total current assets of $3,652,007 and total current liabilities of $422,432, resulting in working capital of $3,229,575. At June 30, 2023, we had $3,221,747 of cash and cash equivalents, a decrease of $2,418,561 from $5,640,308 at December 31, 2022.

During the first six months of 2023, the net cash outflow from operating activities was $2,068,374. This amount was comprised primarily of our net loss of $3,756,244, offset by non-cash stock-based compensation expense of $1,624,949, depreciation and amortization of $53,375, amortization of ROU assets of $57,632, and amortization of prepaid assets of $104,378, and cash used from changes in assets and liabilities of $152,464, primarily from the decrease in other assets of $206,371, ROU liabilities of $47,471, accounts payable of $11,947, and accrued expenses and compensation of $4,331, offset by the increase in accounts receivable of $117,656.

Investing activities reflected $70,631 for the acquisition of equipment.

During the first six months of 2023, the net cash outflow from financing activities was $279,556. This amount consisted of $451,847 in repayment of notes related to the asset purchase agreement and the directors and officer insurance financing, offset by proceeds related to a note in the amount of $155,541 in connection with renewal of the directors and officer insurance and proceeds from the exercise of stock options in the amount of $16,750.

Based on the company’s current business plan, we believe our cash balance as of the date of this report, along with revenue from our ONR grant and existing contract, 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 substantially all of its efforts to developing its business and raising capital, as needed, and 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 unaudited consolidated financial statements do not include any adjustments that might result should the company be unable to continue as a going concern.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2023. Based on that evaluation, our Principal Executive Officer has concluded that our disclosure controls and procedures as of June 30, 2023, are not effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in Internal Controls Over Financial Reporting

There was no change in our internal controls over financial reporting that occurred during the period covered by this report, which has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.