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
Starting in the fourth quarter of 2014 and through the first quarter of 2017,
the company reported as a "shell company" as such term is defined in Rule 12b-2
of the Securities Exchange Act of 1934, as amended due to the suspension of its
previous business activities in October, 2014. The company has developed a
comprehensive research and development program and commenced R&D Activities in
April 2017. Accordingly, the company is no longer a "shell company" and is
reporting as a "smaller reporting company".
In 2017, AERG reactivated its previous business activities pursuant to Teaming
and Consulting Agreements with (i) Applied Optical Sciences, Inc. ("AOS"), (ii)
Stephen W. McCahon, Ph.D., one of the company's founders, a significant
stockholder of the company and owner of AOS, who was primarily responsible for
development of the company's existing Intellectual Property portfolio, and (iii)
each of the members of the Scientific Advisory Board. The Teaming and Consulting
Agreements with AOS and McCahon were superseded by the Asset Purchase Agreement
and Consulting Agreement described below.
Effective April 29, 2019, Applied Energetics established a Board of Advisors to
work with its Board of Directors and key management personnel on specific areas
of significance to the company. Applied Energetics appointed Christopher "Chris"
Donaghey as its first member. Chris comes highly qualified and is familiar with
Applied Energetics and its key technologies. We expect Chris to have significant
input into the strategic direction of the company and provide assistance in
building lasting relationships in our defense markets.
Mr. Donaghey currently serves as the senior vice president and head of corporate
development for Scientific Applications International Corporation ("SAIC"), a
$6.5 billion revenue defense and government agency technology integrator. As an
executive of SAIC, Donaghey works closely with SAIC's senior management to
support the development and implementation of SAIC's strategic plan with an
emphasis on M&A to complement organic growth strategies and value creation.
Gregory J. Quarles was hired as the Chief Executive officer of AERG at the
beginning of May 2019, and shortly thereafter, the company entered into an Asset
Purchase Agreement with AOS on May 29, 2019. AOS is a Tucson-based corporation
of which Stephen W. McCahon is the majority shareholder. Mr. McCahon was also
retained under a Consulting Agreement with AERG and has been retained as the
acting Chief Scientist. AERG has continued to expand its technical capabilities
with the addition of numerous consultants and contractors, and agreements with
several of the leading laser and optics universities in the country. The Asset
Purchase Agreement and Consulting Agreement superseded the 2017 Teaming and
Consulting Agreements with AOS and McCahon.
AERG owns intellectual property that is integral and necessary for the
development of Ultra-Short Pulse ("USP") Lasers, Laser Guided Energy ("LGE") and
Direct Discharge Electrical products for military and commercial applications.
AERG currently owns 26 patents and an additional 11 Government Sensitive Patent
Applications ("GSPA"). These GSPA's are held under secrecy orders of the US
government and allow the company greatly extended protection rights, including
having no expiration date until such time as they are no longer classified after
that they will have the normal 20-year patent protection.
On December 26, 2019, AERG received notification from the Army that it has been
competitively selected for award of a Phase I Small Business Technology Transfer
(STTR) contract. The award is for the development of Standoff Electronic Denial
systems The objective of this award is to develop a directed energy system
capable of disrupting, disabling or destroying the electronics on a remote
target within milliseconds of detection. This award was successfully negotiated
and the contract was executed with a March 4, 2020 start date. The first phase
of the program will be completed by June 5, 2020.
The proposal submitted to the Army STTR program was one of several proposals
submitted in 2019. We are awaiting feedback on these subsequent submissions, but
recognize that our feedback from the agencies could be delayed due to the impact
the corona virus is having on workplaces in all sectors. These delays could
impact feedback, reviews and announcements of awards over the next several
months. We could also experience delays in briefing the various stakeholders,
funding agencies, collaborators and possible system integrators and partners
across the defense and manufacturing markets. At this time, we cannot predict
when we will learn more about our submissions.
15
Path Forward
Our goal 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
expect to develop 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 medical applications.
Although the historical market for AERG's LGE and USP technology is the U.S.
Government, the USP technologies is expected to provide numerous platforms for
commercial manufacturing and medical markets, creating a substantially larger
market for our products to address.
As mentioned elsewhere herein, the ongoing Coronavirus pandemic presents unique
risks and uncertainties that may alter or otherwise affect our path forward. Our
management continues to monitor the possible effects of the coronavirus pandemic
on the execution of our plan of operations, our prospective contracts, and the
availability of financing to fund our plans going forward.
Critical Accounting Policies
Use of Estimates
The preparation of consolidated financial statements in conformity with United
States generally accepted accounting principles requires management to make
estimates, judgments and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Management bases its assumptions on
historical experiences and on various other inputs and estimates that it
believes to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. In addition, management
considers the basis and methodology used in developing and selecting these
estimates, the trends in and amounts of these estimates, specific matters
affecting the amount of and changes in these estimates, and any other relevant
matters related to these estimates, including significant issues concerning
accounting principles and financial statement presentation. Such estimates and
assumptions could change in the future as more information becomes known which
could impact the amounts reported and disclosed herein.
Share-Based Payments
Stock-based compensation cost is measured at grant date, based on the fair value
of the award and is recognized as an expense over the requisite service period.
The fair value of each option grant is estimated at the date of grant using the
Black-Scholes-Merton option valuation model. We make the following assumptions
relative to this model: (i) the annual dividend yield is zero as we do not pay
dividends on our common stock, (ii) the weighted-average expected life is based
on a midpoint scenario, where the expected life is determined to be half of the
time from grant to expiration, regardless of vesting, (iii) the risk free
interest rate is based on the U.S. Treasury security rate for the expected life,
and (iv) the volatility is based on the level of fluctuations in our historical
share price for a period equal to the weighted-average expected life. We
estimate forfeitures when recognizing compensation expense and adjust this
estimate over the requisite service period should actual forfeitures differ from
such estimates. Changes in estimated forfeitures are recognized through a
cumulative adjustment, which is recognized in the period of change and which
impacts the amount of unamortized compensation expense to be recognized in
future periods.
Income Taxes
Deferred tax assets and liabilities are recognized currently for the future tax
consequences attributable to the temporary differences between the financial
statement carrying amounts of assets and liabilities and their respective tax
basis. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. A valuation allowance is recorded to reduce the carrying
amounts of deferred tax assets if it is more likely than not that such assets
will not be realized.
16
Results of Operations
Our consolidated financial information for the years ending December 31, 2019,
and 2018 is as follows:
2019 2018
Revenue $ - $ -
Cost of revenue - -
Operating Expenses:
General and administrative $ (4,622,624 ) $ (2,521,837 )
Selling and marketing (213,738 ) (50,085 )
Research and development (335,445 ) (190,482 )
Total operating expenses (5,171,807 ) (2,762,404 )
Other expense:
Other income 19,046 -
Interest (expense) (403,578 ) (245,343 )
Other expense (384,532 ) (245,343 )
Loss before provision for income taxes (5,556,339 ) (3,007,747 )
Provision for income taxes - -
Net loss $ (5,556,339 ) $ (3,007,747 )
General and Administrative
General and administrative expenses increased approximately $2,101,000 to
$4,623,000 for the year ended December 31, 2019 compared to $2,522,000 for the
year ended December 31, 2018. Consulting and professional services increased by
approximately $1,881,000, wages and employee benefits increased $225,000,
supplies and insurance increased by $60,000, travel increased by $52,000,
building costs increased by $41,000 and depreciation increased by $15,000,
partially offset by recognition of a loss on the early payoff of notes payable
for $174,000 in 2018.
Selling and Marketing
Selling and Marketing expenses increased approximately $164,000 to $214,000 for
the year ended December 31, 2019 compared to $50,000 for the year ended December
31, 2018 primarily due to the continuation of business development activities
through our Master Services Agreement with Westpark Advisors.
Research and Development
Research and development expenses increased approximately $145,000 to $335,000
for the year ended December 31, 2019, compared to $190,000 the year ended
December 31, 2018, primarily due to the initiation of research and development
activities through our teaming agreement with Applied Optical Sciences, Inc. and
our cooperative Research Agreement with the Arizona Board of Regents of the
University of Arizona.
Other Expense
Interest expense for the year ended December 31, 2019 was higher by
approximately $158,000 to $404,000 for the year ended December 31, 2019,
compared to $245,000 the year ended December 31, 2018 primarily due to warrant
expense of $263,000 partially offset by the amortization of the notes payable
beneficial conversion factor and higher levels of historical debt in 2018. Other
income increased $19,000 to $19,000 to reflect the time and effort on the
subcontract to the Missile Defense Agency (thru AlionSciences) as a subject
matter expert on a series of program reviews.
Net Loss
Our operations in 2019 resulted in a net loss of approximately $5,556,000, an
increase of approximately $2,549,000 compared to the approximately $3,008,000
million net loss for 2018 primarily due to an increase in professional fees,
wages and employee benefits, supplies and insurance, travel, building costs,
depreciation, selling and marketing, partially offset by a reduction offset by
recognition of a loss on the early payoff of notes payable 2018 and a lower
other expense. Our net loss attributable to common stockholders per common share
- basic and diluted increased to approximately ($0.03) per share.
17
Trend Discussion
There are obvious costs associated with restarting the corporation and acquiring
the skilled leadership and manpower to execute on new product development, as is
visible in the higher year-over-year expenses recognized in this Result of
Operations. It appears with the year-end contract announcement, and the
anticipated bookings in 2020, that our is too early to determine if efforts to
obtain new business under our Teaming and Consulting Agreements could be
successful for the next fiscal year.
Liquidity and Capital Resources
Going Concern
The accompanying financial statements have been prepared on a going concern
basis, which contemplates the realization of assets and satisfaction of
liabilities in the normal course of business. For the year ended December 31,
2019, the company incurred a net loss of approximately $5,556,000, had negative
cash flows from operations of $3,250,000 and may incur additional future losses
due to the reduction in government contract activity. These matters raise
substantial doubt as to the company's ability to continue as a going concern.
In their report accompanying our financial statements, our independent auditors
stated that our financial statements for the year ended December 31, 2019 and
2018 were prepared assuming that we would continue as a going concern, and that
they have substantial doubt as to our ability to continue as a going concern.
Our auditors have noted that our recurring losses from operations and negative
cash flow from operations and the concern that we may incur additional losses
due to the reduction in Government contract activity raise substantial doubt
about our ability to continue as a going concern.
The company's existence is dependent upon management's ability to develop
profitable operations. Management is devoting substantially all of its efforts
to developing its business and raising capital and there can be no assurance
that the company's efforts will be successful. No assurance can be given that
management's actions will result in profitable operations or the resolution of
its liquidity problems. The accompanying consolidated financial statements do
not include any adjustments that might result should the company be unable to
continue as a going concern.
In order to improve the company's liquidity, the company's management is
actively pursuing additional equity financing through discussions with
investment bankers and private investors. There can be no assurance that the
company will be successful in its effort to secure additional equity financing.
The financial statements do not include any adjustments relating to the
recoverability of assets and the amount or classification of liabilities that
might be necessary should the company be unable to continue as a going concern.
At December 31, 2019, we had approximately $88,000 of cash and cash equivalents,
a decrease of approximately $90,000 from December 31, 2018. In 2019, we used
approximately $3,250,000 in operating activities, comprised primarily of our net
loss of $5,556,000, a decrease in accrued expenses and compensation of $361,000,
a decrease in accounts payable of $222,000, an increase in long-term receivables
of $141,000, partially offset by non-cash stock-based compensation expense of
$2,157,000, an increase in prepaid expenses and deposits of $217,000,
amortization of future compensation payable of $203,000, interest expense of
$397,000, an increase in other receivables of $57,000 and depreciation and
amortization of $15,000.
We used approximately $12,000 in investing activities with the purchase of
equipment.
We had approximately $3,172,000 provided by financing activities comprised of
proceeds from note payable net of financing costs of $2,350,000, $854,000
provided from the proceeds from the issuance of common stock, partially offset
by the repayment on notes payable $32,000. All this resulted in a net cash
outflow of approximately $90,000.
As of March 26, 2020, our backlog was approximately $166,000.
18
Contractual Obligations:
The following table summarizes our contractual obligations and other commercial
commitments as of December 31, 2019:
Payment by Period
Less than 1
Total Year 1 to 3 Years
Notes payable $ 4,967,890 $ 3,467,890 $ 1,500,000
Due to affiliate 50,000
50,000 $ -
Operating leases 4,066 4,066 -
Total $ 5,021,957 $ 3,521,957 $ 1,500,000Not included in the above table are the dividends on our Series A Preferred
Stock that are approximately $34,000 each year (approximately $9,000 each
quarter), assuming no conversion of the outstanding shares of Series A Preferred
Stock into shares of common stock.
Operating Leases
We are operating in leased premises under month-to-month operating leases. Total
rent expense on these spaces amounted to approximately $30,000 for 2019 and
$4,000 for 2018. The increase in lease expenses is due to the lease of the lab
space transitioned in the AOS asset acquisition.
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 in arrears as of February 1, 2020 were approximately
$230,000.
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 $221,000 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, 2019, there were 13,602 shares
of Series A Preferred Stock outstanding.
Recent Accounting Pronouncements
Refer to Note 2 of Notes to Consolidated Financial Statements for a discussion
of recent accounting standards and pronouncements.
Off-Balance Sheet Arrangements
As of December 31, 2019, we had no significant off-balance sheet arrangements
other than operating leases. For a description of our operating lease, see Note
6 to the Consolidated Financial Statements.
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APPLIED ENERGETICS, INC. 
