UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C.  20549





FORM
10-Q





x           Quarterly
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934





For the
quarterly period ended September 30, 2010





OR





 ̈           Transition Report Pursuant to Section
13 or 15(d) of the Securities Exchange Act of 1934


For the
transition period from __________ to __________





Commission
File Number 001-14015





APPLIED
ENERGETICS, INC.





(Exact
Name of Registrant as Specified in Its Charter)





Delaware
            
            77-0262908(State
      or Other Jurisdiction of Incorporation or Organization)
            
            (IRS
      Employer Identification Number)





3590
      East Columbia
      StreetTucson,
      Arizona
            85714(Address
      of Principal Executive Offices)
            (Zip
      Code)





Registrant’s
telephone number, including area
code         (520)
628-7415





Indicate
by check mark whether the registrant: (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  Yes x No  ̈





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


Yes  ̈ No  ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.  (Check one):





Large
      accelerated filer:  ̈
                    Accelerated
      filer:  ̈
                    Non-accelerated
      filer:  ̈
                    Smaller
      reporting company: x(Do
      not check if a smaller reporting
                      company)





Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act)


Yes  ̈ No x





Indicate
the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.  As of November 4, 2010,
there were 90,985,985 shares of the issuer's common stock, par value $.001 per
share, outstanding.





APPLIED
ENERGETICS, INC.


QUARTERLY
REPORT ON FORM 10-Q


TABLE
OF CONTENTS





PART
      I.  FINANCIAL INFORMATIONITEM
      1.
                                      Condensed
      Consolidated Financial Statements
                                      1Condensed
      Consolidated Balance Sheets as of September 30, 2010 (Unaudited) and
      December 31, 2009
                                      1Condensed
      Consolidated Statements of Operations for the three months ended September
      30, 2010 and 2009 (Unaudited)
                                      2Condensed
      Consolidated Statements of Operations for the nine months ended September
      30, 2010 and 2009 (Unaudited)
                                      3Condensed
      Consolidated Statements of Cash Flows for the nine months ended September
      30, 2010 and 2009 (Unaudited)
                                      4Notes
      to Condensed Consolidated Financial Statements
                                      5ITEM
      2.
                                      Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                                      11ITEM
      4.
                                      Controls
      and Procedures
                                      15PART
      II.  OTHER INFORMATIONITEM
      2.
                                      Unregistered
      Sales of Equity Securities and Use of Proceeds
                                      16ITEM
      6.
                                      Exhibits
                                      16SIGNATURES
                                      17




i


PART
I.  FINANCIAL INFORMATION





ITEM
1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





APPLIED ENERGETICS, INC.


CONDENSED
CONSOLIDATED BALANCE SHEETS





September 30, 2010
                    
                    
                    December 31, 2009(Unaudited)ASSETSCurrent
      assetsCash
      and cash equivalents
                    
                    $
                    9,107,418
                    
                    
                    $
                    9,604,643Short
      term investments
                    
                    
                    -
                    
                    
                    
                    225,000Accounts
      receivable
                    
                    
                    2,267,197
                    
                    
                    
                    1,074,944Inventory
                    
                    
                    769,970
                    
                    
                    
                    785,479Prepaid
      expenses and deposits
                    
                    
                    320,762
                    
                    
                    
                    447,295Other
      receivables
                    
                    
                    64,060
                    
                    
                    
                    52,295Total
      current assets
                    
                    
                    12,529,407
                    
                    
                    
                    12,189,656Long
      term receivables - net
                    
                    
                    205,313
                    
                    
                    
                    205,313Property
      and equipment - net
                    
                    
                    2,598,822
                    
                    
                    
                    2,845,607Other
      assets
                    
                    
                    20,800
                    
                    
                    
                    20,800TOTAL
      ASSETS
                    
                    $
                    15,354,342
                    
                    
                    $
                    15,261,376LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilitiesAccounts
      payable
                    
                    $
                    801,171
                    
                    
                    $
                    428,413Accrued
      expenses
                    
                    
                    408,321
                    
                    
                    
                    313,448Short
      term financing
                    
                    
                    -
                    
                    
                    
                    214,834Accrued
      compensation
                    
                    
                    626,579
                    
                    
                    
                    505,188Customer
      deposits
                    
                    
                    414,817
                    
                    
                    
                    104,160Billings
      in excess of costs
                    
                    
                    5,032
                    
                    
                    
                    42,716Total
      current liabilities
                    
                    
                    2,255,920
                    
                    
                    
                    1,608,759Total
      liabilities
                    
                    
                    2,255,920
                    
                    
                    
                    1,608,759Commitments
      and contingenciesStockholders’
      equitySeries
      A Convertible Preferred Stock, $.001 par value, 2,000,000 shares
      authorized; 107,172 shares issued and outstanding at September 30, 2010
      and 135,572 shares issued and outstanding at December 31,
    2009
                    
                    
                    107
                    
                    
                    
                    136Common
      stock, $.001 par value, 125,000,000 shares authorized; 90,928,147 shares
      issued and outstanding at September 30, 2010 and 88,968,812 shares issued
      and outstanding at December 31, 2009
                    
                    
                    90,928
                    
                    
                    
                    88,969Additional
      paid-in capital
                    
                    
                    78,507,296
                    
                    
                    
                    76,931,065Accumulated
      deficit
                    
                    
                    (65,499,909
                    )
                    
                    
                    (63,367,553
                    )Total
      stockholders’ equity
                    
                    
                    13,098,422
                    
                    
                    
                    13,652,617TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                    
                    $
                    15,354,342
                    
                    
                    $
                    15,261,376





See
accompanying notes to condensed consolidated financial statements
(unaudited)


- 1
-





APPLIED
ENERGETICS, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)





For the three months ended
                  September 30,2010
                
                
                2009Revenue
                
                $
                3,260,087
                
                
                $
                1,877,865Cost
      of revenue
                
                
                2,986,640
                
                
                
                1,777,840Gross
      profit
                
                
                273,447
                
                
                
                100,025Operating
      expensesGeneral
      and administrative
                
                
                412,496
                
                
                
                1,348,446Selling
      and marketing
                
                
                135,013
                
                
                
                132,386Research
      and development
                
                
                55,518
                
                
                
                210,925Total
      operating expenses
                
                
                603,027
                
                
                
                1,691,757Operating
      loss
                
                
                (329,580
                )
                
                
                (1,591,732
                )Other
      (expense) incomeInterest
      expense
                
                
                (1,111
                )
                
                
                -Interest
      income
                
                
                2,074
                
                
                
                8,388Total
      other
                
                
                963
                
                
                
                8,388Net
      loss
                
                
                (328,617
                )
                
                
                (1,583,344
                )Preferred
      stock dividends
                
                
                (45,839
                )
                
                
                (76,941
                )Net
      loss attributable to common stockholders
                
                $
                (374,456
                )
                
                $
                (1,660,285
                )Net
      loss per common share – basic and diluted
                
                $
                (0.004
                )
                
                $
                (0.02
                )Weighted
      average number of shares outstanding, basic and diluted
                
                
                89,791,303
                
                
                
                86,179,071





See
accompanying notes to condensed consolidated financial statements
(unaudited)


- 2
-





APPLIED
ENERGETICS, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)





For the nine months ended
                    September 30,2010
                  
                  
                  2009Revenue
                  
                  $
                  9,734,797
                  
                  
                  $
                  6,195,404Cost
      of revenue
                  
                  
                  9,150,009
                  
                  
                  
                  5,810,602Gross
      profit
                  
                  
                  584,788
                  
                  
                  
                  384,802Operating
      expensesGeneral
      and administrative
                  
                  
                  2,015,082
                  
                  
                  
                  6,609,231Selling
      and marketing
                  
                  
                  439,366
                  
                  
                  
                  561,410Research
      and development
                  
                  
                  92,038
                  
                  
                  
                  1,051,572Total
      operating expenses
                  
                  
                  2,546,486
                  
                  
                  
                  8,222,213Operating
      loss
                  
                  
                  (1,961,698
                  )
                  
                  
                  (7,837,411
                  )Other
      (expense) incomeInterest
      expense
                  
                  
                  (4,446
                  )
                  
                  
                  (19
                  )Interest
      income
                  
                  
                  6,646
                  
                  
                  
                  56,222Total
      other
                  
                  
                  2,200
                  
                  
                  
                  56,203Net
      loss
                  
                  
                  (1,959,498
                  )
                  
                  
                  (7,781,208
                  )Preferred
      stock dividends
                  
                  
                  (161,380
                  )
                  
                  
                  (187,093
                  )Deemed
      dividend from induced conversion of Series
      A Preferred Stock
                  
                  
                  (11,478
                  )
                  
                  
                  -Net
      loss attributable to common stockholders
                  
                  $
                  (2,132,356
                  )
                  
                  $
                  (7,968,301
                  )Net
      loss per common share – basic and diluted
                  
                  $
                  (0.02
                  )
                  
                  $
                  (0.09
                  )Weighted
      average number of shares outstanding, basic and diluted
                  
                  
                  89,179,404
                  
                  
                  
                  86,186,310





See
accompanying notes to condensed consolidated financial statements
(unaudited)


- 3
-


APPLIED
ENERGETICS, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)





For the nine months ended
                        September 30,2010
                      
                      
                      2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
                      
                      $
                      (1,959,498
                      )
                      
                      $
                      (7,781,208
                      )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
                      
                      
                      305,668
                      
                      
                      
                      498,758Loss
      on equipment disposal
                      
                      
                      5,725
                      
                      
                      
                      106,873Provision
      for inventory reserves
                      
                      
                      36,000
                      
                      
                      
                      -Litigation
      settlement payable in common stock
                      
                      
                      -
                      
                      
                      
                      1,200,000Non-cash
      stock based compensation expense
                      
                      
                      814,422
                      
                      
                      
                      1,335,734Changes
      in assets and liabilities:Accounts
      receivable
                      
                      
                      (1,192,253
                      )
                      
                      
                      1,421,201Other
      receivable
                      
                      
                      1,710
                      
                      
                      
                      (244,666
                      )Inventory
                      
                      
                      (20,491
                      )
                      
                      
                      (218,625
                      )Prepaid
      expenses and deposits
                      
                      
                      126,533
                      
                      
                      
                      385,367Long
      term receivables - net
                      
                      
                      -
                      
                      
                      
                      253,130Accounts
      payable
                      
                      
                      372,758
                      
                      
                      
                      (558,274
                      )Billings
      in excess of costs
                      
                      
                      (37,684
                      )
                      
                      
                      20,426Accrued
      expenses, customer deposits and deferred rent
                      
                      
                      312,087
                      
                      
                      
                      68,102Net
      cash (used in) operating activities
                      
                      
                      (1,235,023
                      )
                      
                      
                      (3,513,182
                      )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of building and equipment
                      
                      
                      (78,670
                      )
                      
                      
                      (9,315
                      )Proceeds
      from sale of short term investments
                      
                      
                      225,000
                      
                      
                      
                      -Proceeds
      from disposal of equipment
                      
                      
                      14,062
                      
                      
                      
                      -Net
      cash (used in)/provided by investing activities
                      
                      
                      160,392
                      
                      
                      
                      (9,315
                      )CASH
      FLOWS FROM FINANCING ACTIVITIES:Dividends
      paid (preferred stock)
                      
                      
                      -
                      
                      
                      
                      (129,123
                      )Exercise
      of stock options
                      
                      
                      577,406
                      
                      
                      
                      -Principal
      payments on capital lease obligations
                      
                      
                      -
                      
                      
                      
                      (2,028
                      )Net
      cash (used in)/provided by financing activities
                      
                      
                      577,406
                      
                      
                      
                      (131,151
                      )Net
      decrease in cash and cash equivalents
                      
                      
                      (497,225
                      )
                      
                      
                      (3,653,648
                      )Cash
      and cash equivalents, beginning of period
                      
                      
                      9,604,643
                      
                      
                      
                      15,467,386Cash
      and cash equivalents, end of period
                      
                      $
                      9,107,418
                      
                      
                      $
                      11,813,738





See
accompanying notes to condensed consolidated financial statements
(unaudited)


- 4
-


APPLIED
ENERGETICS, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 
 1.          
   BASIS OF PRESENTATION
 
 The
accompanying interim unaudited condensed consolidated financial statements
include the accounts of Applied Energetics, Inc. and its wholly owned
subsidiaries, Ionatron Technologies, Inc. and North Star Power Engineering, Inc.
as of September 30, 2010 (collectively, "company," "Applied Energetics," "we,"
"our" or "us").  All intercompany balances and transactions have been
eliminated.  In the opinion of management, all adjustments (which
include normal recurring adjustments) necessary for a fair presentation of the
results for the interim periods presented have been made.  The results
for the nine month period ended September 30, 2010, may not be indicative of the
results for the entire year.  The interim unaudited condensed
consolidated financial statements should be read in conjunction with the
company's audited consolidated financial statements contained in our Annual
Report on Form 10-K.
 
 The
following unaudited condensed financial statements are presented pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain
information and note disclosures normally included in annual financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to those rules and regulations, although
the company believes that the disclosures made are adequate to make the
information not misleading.
 
 USE
OF ESTIMATES
 
 The
preparation of consolidated financial statements in conformity with United
States Generally Accepted Accounting Principles (“GAAP”) 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 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.  Significant estimates include revenue recognition under the
percentage of completion method of contract accounting, estimating costs at
completion on a contract, the valuation of inventory, and expected forfeiture
rate on stock-based compensation.
 
 CASH
AND CASH EQUIVALENTS
 
 We
consider all highly liquid investments with maturities of three months or less
to be cash equivalents.  At September 30, 2010, we had approximately
$9.1 million of cash and cash equivalents.
 
 FAIR
VALUE OF FINANCIAL INSTRUMENTS
 
 The
carrying amounts of accounts receivable, accounts payable, and accrued expenses
approximate fair value due to the short maturity of these
instruments.
 
 RECENT
ACCOUNTING PRONOUNCEMENTS
 
 The
Financial Accounting Standards Board (“FASB”) has issued Accounting Standards
Update (“ASU”) No. 2010-20, “Disclosures about the Credit Quality of Financing
Receivables and the Allowance for Credit Losses (“ASU 2010-20”) which is
intended to provide financial statement users with greater transparency about an
entity’s allowance for credit losses and the credit quality of its financial
receivables.  ASU 2010-20 is effective for us at year
end.  As the ASU specifically excludes short-term trade accounts
receivable, the adoption of the standard is not expected to have a significant
impact on the company’s consolidated financial statements.
  - 5
-
  APPLIED
ENERGETICS, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 
 2.              ACCOUNTS
RECEIVABLE
 
 Accounts
receivable consists of the following:
 
 September 30, 2010
                            
                            
                            December 31, 2009Contracts
      receivable
                            
                            $
                            2,256,937
                            
                            
                            $
                            1,031,960Costs
      and estimated earnings on uncompleted contracts
                            
                            
                            10,260
                            
                            
                            
                            42,984Accounts
      receivable, net
                            
                            $
                            2,267,197
                            
                            
                            $
                            1,074,944Short
      term receivable (contract retention)
                            
                            
                            47,817
                            
                            
                            
                            47,817Long
      term receivable (contract retention)
                            
                            
                            205,313
                            
                            
                            
                            205,313$
                            2,520,327
                            
                            
                            $
                            1,328,074
 
 Contracts
receivable are expected to be collected within a year.
 
 Costs and
Estimated Earnings on Uncompleted Contracts
 September 30, 2010
                            
                            
                            December 31, 2009Costs
      incurred on uncompleted contracts
                            
                            
                            27,968,346
                            
                            
                            $
                            18,890,642Estimated
      earnings
                            
                            
                            2,085,422
                            
                            
                            
                            1,479,680Total
      billable costs and estimated earnings
                            
                            
                            30,053,768
                            
                            
                            
                            20,370,322Less:Billings
      to date
                            
                            
                            30,048,540
                            
                            
                            
                            20,370,054Total
                            
                            $
                            5,228
                            
                            
                            $
                            268Included
      in accompanying balance sheet:Unbilled
      costs and estimated earnings on uncompleted contracts included in accounts
      receivable
                            
                            $
                            10,260
                            
                            
                            $
                            42,984Billings
      in excess of costs and estimated earnings on uncompleted
      contracts
                            
                            
                            (5,032
                            )
                            
                            
                            (42,716
                            )Total
                            
                            $
                            5,228
                            
                            
                            $
                            268
  - 6
-
  APPLIED
ENERGETICS, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 
 3.              INVENTORY
 
 Our
inventories consist of the following:
 
 September 30, 2010
                    
                    
                    December 31, 2009Raw
      materials
                    
                    $
                    75,011
                    
                    
                    $
                    103,451Work-in-process
                    
                    
                    752,959
                    
                    
                    
                    704,028Provision
      for loss on project
                    
                    
                    (58,000
                    )
                    
                    
                    (22,000
                    )Total
                    
                    $
                    769,970
                    
                    
                    $
                    785,479
 
 4.        
  PROPERTY AND EQUIPMENT
 
 Our
property and equipment consist of the following:
 
 September 30, 2010
                    
                    
                    December 31, 2009Land
      and buildings
                    
                    $
                    2,103,215
                    
                    
                    $
                    2,072,215Equipment
                    
                    
                    2,284,136
                    
                    
                    
                    2,677,926Furniture
      and building improvements
                    
                    
                    843,464
                    
                    
                    
                    858,379Software
                    
                    
                    813,799
                    
                    
                    
                    800,566Total
                    
                    
                    6,044,614
                    
                    
                    
                    6,409,086Less
      accumulated depreciation and amortization
                    
                    
                    (3,445,792
                    )
                    
                    
                    (3,563,479
                    )Net
      property and equipment
                    
                    $
                    2,598,822
                    
                    
                    $
                    2,845,607
 
 Periodically,
we evaluate general impairment of assets.  As an element of our annual
business planning process conducted in the fourth quarter of each year, we
consider expected revenues and resulting cash flow from operations. Revenue
planning is based upon actual and expected contract awards as the majority of
our revenues are sourced from Government contracts. During this process, we
evaluate the current carrying values of all long-lived assets on our books.
 We compare these values against business plans to determine if carrying
values are recoverable.
 
 Our most
recent asset impairment test was performed on February 15, 2010, when we
determined that as of December 31, 2009 the net book values of long-lived assets
were recoverable through expected undiscounted business cash flows based on
anticipated and actual future revenue bookings and backlog. We will continue to
evaluate the carrying values in the future.  We evaluate impairments as
such circumstances warrant.
  - 7
-
  APPLIED
ENERGETICS, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 
 5.        
  SHARE-BASED COMPENSATION
 
 Share-Based Compensation –
Employees and Directors
 
 For the
three months ended September 30, 2010 and 2009, share-based compensation expense
totaled $156,000 and $237,000, respectively.  For the nine months
ended September 30, 2010 and 2009, share-based compensation expense totaled
$814,000 and $1.3 million, respectively.
 
 There was
no related income tax benefit recognized because our deferred tax assets are
fully offset by a valuation allowance.
 
 As of
September 30, 2010, $116,000 of total unrecognized compensation cost related to
restricted stock is expected to be recognized over a weighted average period of
approximately .17 years.
 
 The Board
granted options to purchase an aggregate of 30,000 shares of our common stock
during the three months ended September 30, 2010 to an employee.  The
options are exercisable at a price per share of $1.29 and expire on July 27,
2015.  One-third of the options became exercisable on February 8,
2011, and on the yearly anniversary until completely vested.
 
 The
weighted average grant-date fair value of all outstanding option grants was
$0.40 and $0.14 per share, for the nine months ended September 30, 2010 and
2009, respectively.  We determine the fair value of share-based awards
at their grant date, using a Black-Scholes Option-Pricing Model applying the
assumptions in the following table.
 
 Nine Months Ended September
    30,2010
                    
                    
                    2009Expected
      life (years)
                    
                    2.9
      - 3 years
                    
                    
                    3
      yearsDividend
      yield
                    
                    
                    0.0
                    %
                    
                    
                    0.0
                    %Expected
      volatility
                    
                    
                    93.6
                    %
                    
                    
                    67.3
                    %Risk
      free interest rates
                    
                    
                    1 -
      1.5
                    %
                    
                    
                    1.3
                    %Weighted
      average fair value of options at grant date
                    
                    $
                    0.37
                    
                    
                    $
                    0.14
 
 During
the nine months ended September 30, 2010, 112,507 shares of restricted stock
vested and 16,407 shares of restricted stock were forfeited.  The
Board granted 460,000 shares of common stock to the members of the Board of
Directors, which were fully vested upon grant.  During the nine months
ended September 30, 2010, options to purchase 1,278,427 shares of common stock
were exercised and the cash proceeds from the option exercises totaled
approximately $577,000.  Included as other receivables on the balance
sheet as of September 30, 2010 was an additional $13,475 of exercise price,
which was not paid as of the balance sheet date.  These funds were
received on October 19, 2010.
 
 Warrants –
Non-Employees
 
 At
September 30, 2010 and December 31, 2009 there were outstanding warrants to
purchase approximately 1.0 million shares of common stock, which were either (i)
issued in connection with the August 2006 financing, or (ii) issued to outside
consultants.  The exercise price of the warrants ranges from $9.15 to
$12.00.
 
 6. 
         SIGNIFICANT
CUSTOMERS
 
 Approximately
99% and 100% of revenues for the three-month periods ended September 30, 2010
and 2009 are generated from either the U.S. Government or contractors to the
U.S. Government.  Approximately 99% and 96% of revenues for the nine
month periods ended September 30, 2010 and 2009 are generated from either the
U.S. Government or contractors to the U.S. Government.
  - 8
-
  APPLIED
ENERGETICS, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 
 7.   
       NET LOSS PER SHARE
 
 Basic net
income (loss) per common share is computed by dividing net income (loss)
available to common shareholders by the weighted average number of common shares
outstanding during the period before giving effect to stock options, stock
warrants, restricted stock units and convertible securities outstanding, which
are considered to be dilutive common stock equivalents.  Diluted net
income (loss) per common share is calculated based on the weighted average
number of common and potentially dilutive shares outstanding during the period
after giving effect to convertible preferred stock, stock options, warrants and
restricted stock units. Contingently issuable shares are included in the
computation of basic earnings (loss) per share when issuance of the shares is no
longer contingent. Due to the losses from continuing operations for the nine
months ended September 30, 2010 and 2009, basic and diluted loss per common
share were the same, as the effect of potentially dilutive securities would have
been anti-dilutive.
 
 Potentially
dilutive securities not included in the diluted loss per share calculation, due
to net losses from continuing operations, were as follows:
  Nine Months Ended September
    30,2010
                    
                    
                    2009Options
      to purchase common shares
                    
                    
                    4,245,255
                    
                    
                    
                    4,842,132Warrants
      to purchase common shares
                    
                    
                    1,024,939
                    
                    
                    
                    1,024,939Unvested
      restricted stock units
                    
                    
                    -
                    
                    
                    
                    127,508Convertible
      preferred stock
                    
                    
                    107,172
                    
                    
                    
                    135,572Total
      potentially dilutive securities
                    
                    
                    5,377,366
                    
                    
                    
                    6,130,151
 
 8.       
  DIVIDENDS
 
 As of
September 30, 2010, we had 107,172 shares of our 6.5% Series A Convertible
Preferred Stock outstanding.  A dividend was declared and paid in
common stock on November 1, 2010 to the holders of record as of October 15,
2010.
 
 Dividends
on Preferred Stock are accrued when the amount and kind of the dividend is
determined and are payable quarterly on the first day of February, May, August
and November, in cash or shares of common stock, at the discretion of the
company.
 
 In
September, 27,400 shares of Series A Convertible Preferred Stock were converted
by the holder(s) into 57,083 shares of common stock pursuant to the terms of the
Series A Convertible Preferred Stock.
 
 9.     
    COMMITMENTS AND CONTINGENCIES
 
 LITIGATION
 
 On
February 1, 2010, NewOak Capital Markets, LLC, formerly known as J. Giordano
Securities, LLC, the placement agent for our October 2005 private placement of
preferred stock, commenced an arbitration proceeding against us with Financial
Industry Regulatory Authority (“FINRA”).  NewOak alleges that we made
material misrepresentations between May 2005 and May 10, 2006 concerning the
status of our products.
 
 We
previously settled class action and derivative lawsuits relating to the alleged
misrepresentations.  NewOak, however, opted out of the class action
and alleges that the alleged misrepresentations constituted breaches of its
agreement with the company and that we breached warranties we made to NewOak in
connection with the 2005 private placement.  NewOak seeks
indemnification and recovery for alleged breach of contract, unjust enrichment,
quantum meruit, fraudulent misrepresentation, tortuous interference with
prospective economic relations and violation of Section 10(b) of the Exchange
Act and Rule 10b-5 promulgated thereunder, and seeks an award of monetary
damages in excess of $10 million, plus punitive damages and attorney’s fees and
costs.
  - 9
-
  APPLIED
ENERGETICS, INC.
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 September
30, 2010
 (Unaudited)
 
 We filed
a petition in the Supreme Court of the State of New York, New York County to
stay the arbitration on the ground that the claims are not subject to
arbitration.  NewOak removed the proceeding to the United States
District Court, Southern District of New York, and filed a motion to compel
arbitration.
 
 United
States Magistrate Judge Gabriel Gorenstein issued a Report and Recommendation
dated October 5, 2010 that NewOak’s motion to compel arbitration should be
denied.  NewOak has filed an objection to the Magistrate Judge’s
Report.
 
 In the
event NewOak continues to pursue its claim, we intend to defend ourselves
vigorously in any legal proceeding, and believe we have substantial defenses to
the claims.
 
 In
addition, we may from time to time be involved in legal proceedings arising from
the normal course of business.  As of the date of this report, we have
not received notice of any other legal proceedings.
 
 10.        SUBSEQUENT
EVENTS
 
 We
performed an evaluation of subsequent events and determined that no events
required disclosure.
  - 10
-
  ITEM
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
 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 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, 2009.
 
 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,
performances or achievements to be materially different from any future results,
performances 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, as amended, for the year ended
December 31, 2009 and our Quarterly Report on Form 10-Q for the period ended
March 31, 2010.  In making these forward-looking statements, we claim
the protection of the safe-harbor for forward-looking statements contained in
the Private Securities Reform Act of 1995.  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.
 
 OVERVIEW
 
 Applied
Energetics is a leader in the development and manufacture of applied energy
systems for military and commercial applications.  Through our efforts
in developing our core technology, Laser Guided Energy (“LGE”TM), we have gained
expertise and proprietary knowledge in high performance ultrashort pulse lasers,
high-voltage electronics, advanced dynamic optics and atmospheric and plasma
interactions.  We apply these technologies to deliver innovative
solutions to urgent military requirements, including neutralizing improvised
explosive devices (“IEDs”) and other high priority missions of U.S. and allied
military forces.  We have developed an effective and robust
counter-IED (“CIED”) technology as a result of our research and
development.  Additionally, we develop and manufacture high-voltage
and ultrashort pulse laser products for government and commercial customers for
a range of applications.
 
 During
the third quarter of 2010, we continued to support our US Marine Corps (“USMC”)
customers’ CIED requirements.  This has involved supporting extended
field operations overseas, the production of additional subsystems and spare
parts, training of new operators and support of additional military
units.  We continue to work with the Marine Corps Systems Command on
developing a smaller version of the technology for installation on other
military platforms and vehicles, and upgrading the engineering documentation of
the system.  This work is being performed under the $10.4 million
contract modification received in January of 2010.  In August 2010, we
entered into a strategic teaming agreement with L-3 Interstate Electronics
Corporation (“L-3 IEC”) for pursuit of additional CIED
contracts.  This agreement allows us to focus on technology
development, the development of high voltage systems, systems integration and
testing and field support for our customers.  L-3 IEC will provide
expertise in electronics design and manufacturing, systems engineering, and
configuration management.  We believe that this agreement positions us
well as we expand our CIED product line.  Discussions with other large
defense contractors in developing teaming arrangements to support other
strategic pursuits are continuing.  We expect that utilizing the
resources and capabilities of established Department of Defense (“DoD”)
contractors will allow us to focus on the technology development within our core
capabilities.  Organizations we have identified have experience and a
sound track record in delivering fully qualified military systems and the
associated documentation and certifications to DoD customers.
  - 11
-
  During
the third quarter of 2010, we continued the development and advancement of our
LGE technology by working with our customer, the U.S. Army’s Research,
Development and Engineering Command, who provided a $1.8 million increase in
funding in June to our existing Army contract.  This brings the total
contract value to $4.9 million.  Additionally, we completed a 300kV
Electron Beam Gun system for a major chemical manufacturer, utilizing our Nested
High Voltage Generator technology.  We are awaiting customer final
acceptance of this unit at their facility.  We continue to pursue
contracts with several commercial and government customers in the areas of high
voltage and ultrashort pulse lasers.
 
 In
October, we hired a Vice President of Business Development whose office is based
in the Washington, DC area, as the majority of revenue presently is the result
of US Government contracts.  We believe this will allow us to better
serve our existing Government customers, and develop new customers with a
constant presence and focus in the geographic area in which substantially all of
our Government customers and potential customers are located.
 
 RESULTS
OF OPERATIONS
 
 COMPARISON
OF OPERATIONS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2010 AND
2009:
 
 2010
                      
                      
                      2009Revenue
                      
                      $
                      3,260,087
                      
                      
                      $
                      1,877,865Cost of revenue
                      
                      
                      2,986,640
                      
                      
                      
                      1,777,840General
      and administrative
                      
                      
                      412,496
                      
                      
                      
                      1,348,446Selling
      and marketing
                      
                      
                      135,013
                      
                      
                      
                      132,386Research
      and development
                      
                      
                      55,518
                      
                      
                      
                      210,925Other
      (expense) income:Interest
      expense
                      
                      
                      (1,111
                      )
                      
                      
                      -Interest
      income
                      
                      
                      2,074
                      
                      
                      
                      8,388Net
      loss
                      
                      $
                      (328,617
                      )
                      
                      $
                      (1,583,344
                      )
 
 REVENUE
 
 Revenue
increased by approximately $1.4 million to $3.3 million for the three months
ended September 30, 2010 compared to $1.9 million for the three months ended
September 30, 2009.  Revenue from the CIED product line increased by
$1.8 million to $2.4 million as work continues on the $10.4 million contract
modification received in January 2010.  Revenue from the High Voltage
product line also increased by $17,000 to $27,000.  LGE product line
revenue decreased by $272,000 to $866,000, and Ultrashort Pulse Laser product
line had no revenue, a decrease of $116,000.
 
 COST
OF REVENUE
 
 Cost of
revenue includes manufacturing labor, benefits and overhead, and an allocation
of allowable general and administration and research and development costs in
accordance with the terms of our government contracts.
 
 Cost of
revenue increased by approximately $1.2 million to $3.0 million for the three
months ended September 30, 2010, compared to $1.8 million for the three months
ended September 30, 2009.  The increase in cost of revenue is tied to
the increase in sales revenue of 74% and to inventory adjustments of $49,000
that occurred in 2009.
 
 GENERAL
AND ADMINISTRATIVE
 
 General
and administrative expenses decreased by approximately $936,000 to $413,000 for
the three months ended September 30, 2010 compared to $1.35 million for the
three months ended September 30, 2009.  The change was the result of
decreases in salaries, wages and benefits of approximately $110,000 due to our
staff reductions which took place in 2009; non-cash compensation costs of
approximately $99,000; supplies and building related expenses of $39,000 due to
the consolidation of our facilities, which reduced overall operational costs in
2010; and depreciation and amortization expense of $20,000.  Applied
labor, overhead and material handling costs allocated to cost of revenue
increased by approximately $419,000, further reducing general and administrative
expenses.  In addition, there was a reduction in legal costs of
approximately $243,000 due to the settlement of class action and derivative
lawsuits in 2009.
  - 12
-





SELLING
AND MARKETING





Selling
and marketing expenses were $135,000 for the three months ended September 30,
2010 compared to $132,000 for the three months ended September 30,
2009.  Business development activities associated with the new Laser
and High voltage product lines increased by $57,000 as we continue to focus on
entering new markets for these products and grow our non-government market
revenue.  Offsetting the increase in business development are
reductions in general marketing expenses and reduced tradeshow participation
expenses of approximately $54,000.





RESEARCH
AND DEVELOPMENT





Internal
research and development expenses decreased by approximately $156,000 to $55,000
during the three months ended September 30, 2010 compared to $211,000 for the
three months ended September 30, 2009.  Our internal research and
development costs involve experimentation, design, development and enhancement
of proprietary technologies and new products.  The decrease in
internal research and development expense is primarily due to the deployment of
key technical personnel to fulfilling current contracts.





INTEREST
INCOME AND INTEREST EXPENSE





Net
interest income for the three months ended September 30, 2010 was lower by
approximately $6,000 as compared to the three months ended September 30, 2009
primarily due to the lower balance of invested funds.





NET
LOSS





Our
operations for the three months ended September 30, 2010 resulted in a net loss
of approximately $329,000, an improvement of approximately $1.3 million compared
to the $1.6 million loss for the three months ended September 30,
2009.





COMPARISON
OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2010 AND
2009:





2010
                    
                    
                    2009Revenue
                    
                    $
                    9,734,797
                    
                    
                    $
                    6,195,404Cost of revenue
                    
                    
                    9,150,009
                    
                    
                    
                    5,810,602General
      and administrative
                    
                    
                    2,015,082
                    
                    
                    
                    6,609,231Selling
      and marketing
                    
                    
                    439,366
                    
                    
                    
                    561,410Research
      and development
                    
                    
                    92,038
                    
                    
                    
                    1,051,572Other
      (expense) income:Interest
      expense
                    
                    
                    (4,446
                    )
                    
                    
                    (19
                    )Interest
      income
                    
                    
                    6,646
                    
                    
                    
                    56,222Net
      loss
                    
                    $
                    (1,959,498
                    )
                    
                    $
                    (7,781,208
                    )





REVENUE





Revenue
increased by approximately $3.5 million to $9.7 million for the nine months
ended September 30, 2010 compared to $6.2 million for the nine months ended
September 30, 2009.  Revenue from the CIED product line increased by
$4.6 million to $6.6 million and the Ultrashort Pulse Laser product line revenue
increased by approximately $550,000 to $665,000.  Offsetting these
increases were the decreases in revenue from the LGE product line of
approximately $1.5 million and the High Voltage line of approximately
$61,000.





COST
OF REVENUE





Cost of
revenue includes manufacturing labor, benefits and overhead, and an allocation
of allowable general and administration and research and development costs in
accordance with the terms of our government contracts.


- 13
-





Cost of
revenue increased approximately $3.3 million to $9.1 million for the nine months
ended September 30, 2010, compared to $5.8 million for the nine months ended
September 30, 2009.  The increase in cost of revenue is tied to the
increase in sales revenue of 57% and to provisions for losses on current
contracts of approximately $51,000; which are tied to the High Voltage and Laser
product lines.





GENERAL
AND ADMINISTRATIVE





General
and administrative expenses decreased by approximately $4.6 million to $2.0
million for the nine months ended September 30, 2010 compared to $6.6 million
for the nine months ended September 30, 2009.  The improvement was the
result of decreases in salaries, wages, benefits and temporary help of
approximately $1.4 million due to our downsizing efforts which took place in
2009; non-cash compensation costs of approximately $533,000; supplies and
building related expenses of $316,000 due to the consolidation of our facilities
which reduced overall operations costs in 2010; professional services of
$202,000; depreciation and amortization expense of $193,000; and travel related
expenses of $47,000.  Applied labor, overhead and material handling
costs allocated to cost of revenue increased by $605,000, further reducing
general and administrative expense.  In addition, there was a
reduction in legal costs of approximately $1.2 million from the settlement of
the class action and derivative lawsuits that occurred in 2009 and asset
disposals of $93,000 for leasehold improvements made to our former St. Louis
facility in 2009.





SELLING
AND MARKETING





Selling
and marketing expenses decreased by approximately $122,000 to $439,000 for the
nine months ended September 30, 2010 compared to $561,000 for the nine months
ended September 30, 2009.  The decrease is related to reductions in
general marketing expenses and reduced tradeshow participation expenses of
$83,000 and to reductions in business development activities of
$39,000.  During 2010 we continue to focus our business development
activities on our Laser and High voltage product lines to grow our
non-government market revenue.





RESEARCH
AND DEVELOPMENT





Internal
research and development expenses decreased by approximately $960,000 to $92,000
during the nine months ended September 30, 2010 as compared to $1.1 million for
the nine months ended September 30, 2009.  Our internal research and
development costs involve experimentation, design, development and enhancement
of proprietary technologies and new products.  The decrease in
internal research and development expense is primarily due to deployment of key
technical personnel to fulfill current contracts.





INTEREST
INCOME AND INTEREST EXPENSE





Net
interest income for the nine months ended September 30, 2010 was lower by
approximately $50,000 as compared to the nine months ended September 30, 2009
primarily due to the lower balance of invested funds.





NET
LOSS





Our
operations for the nine months ended September 30, 2010 resulted in a net loss
of approximately $2.0 million, an improvement of approximately $5.8 million
compared to the $7.8 million loss for the nine months ended September 30,
2009.





LIQUIDITY
AND CAPITAL RESOURCES





At
September 30, 2010, we had approximately $9.1 million of cash and cash
equivalents.  Our cash position increased by $179,000 for the three
months ended September 30, 2010, while the total cash decreased for the first
nine months of 2010 by approximately $497,000.  During the first nine
months of 2010, we used $1.2 million of cash in operating activities, which was
primarily comprised of our net loss of $2.0 million, and increases in accounts
receivables and inventory of approximately $1.2 million.  Partially
offsetting these amounts were non-cash compensation expense of $814,000, an
increase in accounts payable and accrued expenses of $685,000, a decrease in
prepaid expenses of $127,000, and depreciation and amortization of approximately
$306,000.  Additionally, investing activities provided approximately
$160,000, and financing activities provided approximately $577,000 in proceeds
from employee option exercises.


- 14
-





We
anticipate that short-term and long-term funding needs will be provided by
existing cash and cash equivalents and the cash flows from servicing our
government contracts.  We believe that we have sufficient working
capital to fulfill existing contracts and expected contracts for at least the
next twelve months.  Government contracts, which currently represent a
major portion of our current activity, are on a cost plus fixed fee
basis.  This means all work performed is done at our
Government-approved rates, which include general and administrative costs,
overhead, labor and materials, fees and profit. These costs are accrued as
incurred and billed monthly.





BACKLOG
OF ORDERS





At
September 30, 2010, we had a backlog (workload remaining on signed contracts) of
approximately $6.4 million, to be completed within the next twelve
months.





ITEM
4.  CONTROLS AND PROCEDURES





EVALUATION
OF DISCLOSURE CONTROLS AND PROCEDURES





Our
management, with the participation of our Principal Executive Officer and Chief
Financial Officer, evaluated the effectiveness of our disclosure controls and
procedures as of September 30, 2010.  Based on that evaluation, our
Principal Executive Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures are 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.





During
the three months ended September 30, 2010, there was no significant change in
our internal controls over financial reporting that has materially affected or
which is reasonably likely to materially affect our internal controls over
financial reporting.


- 15
-


PART
II – OTHER INFORMATION





ITEM
      2.
            UNREGISTERED
      SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS





In
September, 27,400 shares of Series A Convertible Preferred Stock were converted
by the holder(s) into 57,083 shares of common stock pursuant to the original
conversion terms of the Series A Convertible Preferred Stock.





ITEM
      6.
            EXHIBITS





EXHIBIT
                  NUMBER
                
                DESCRIPTION31.1
                
                Certification
      of Principal Executive Officer pursuant to Rule 13a-14 or 15d-14 of the
      Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.31.2
                
                Certification
      of Chief Financial Officer pursuant to Rule 13a-14 or 15d-14 of the
      Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002.32.1
                
                Principal
      Executive Officer Certification pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.32.2
                
                Chief
      Financial Officer Certification pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.


- 16
-





SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.




APPLIED
      ENERGETICS, INC.By
                  /s/
                  Joseph C. HaydenJoseph
      C. HaydenPresident,
      Chief Operating Officer and Principal Executive Officer





Date:  November
8, 2010


- 17
-