Applied Energetics (AERG) Risk Analysis

As we work to develop and demonstrate prototypes and eventually produce and sell products to customers, our business exposes us to potential liability risks that are inherent in the production, demonstration, manufacturing, marketing and sale of laser products to customers. We may be held liable if any of our products under development or other future products cause injury or death or are otherwise malfunction during demonstration or usage. Our products under development are expected to incorporate sophisticated laser components and computer software. Complex software can contain errors, particularly when first introduced. In addition, new products or enhancements may contain undetected errors or performance problems that, despite testing, are discovered only after delivery and use by customers. While we believe our technology will be safe, users may allege or possibly prove defects, some of which could be alleged or proved to cause harm to users or others. While most of our laser technology is considered "eye-safe," certain of our products under development are designed to operate in bands that could cause harm to vision or even total blindness. These products will require safety precautions and procedures, both by our internal team during product development and demonstrations and by prospective customers during demonstrations or customers using these products. In addition to the foregoing, we have begun testing our prototypes at testing ranges outside of our laboratory facilities. These facilities are general in remote areas and configured so as to make testing relatively safe if certain protocols identified by our LSO are followed. While we endeavor to comply with all applicable safety regulations promulgated by the relevant agencies, including without limitation, the Occupational Health and Safety Administration (OSHA), the Federal Aviation Administration and the Food and Drug Administration, as well as any applicable requirements under state law, we cannot be certain that testing of our lasers will not cause serious harm or injury either to personnel involved with the testing or third parties. A product liability claim, regardless of its merit or eventual outcome, could result in significant legal defense costs. We cannot guarantee that we will be able to obtain products liability insurance; if we do, however, the coverage limits of any insurance policies that we may choose to purchase to cover related risks may not be adequate to cover future claims, and the cost of insurance, if obtainable, could be prohibitive. If sales of our products increase or we suffer future product liability claims, we may be unable to maintain product liability insurance in the future at satisfactory rates or with adequate amounts. Similarly, the potential risks associated with some of our lasers could result in substantial premiums for workers compensation insurance. We intend to advance our products to manufacture, whether in contract with one or more third parties or in our own facilities, we could also face product recalls or warranty claims. A product liability claim, any product recalls or excessive warranty claims, whether arising from defects in design or manufacture or otherwise, could negatively affect our sales or require a change in the design or manufacturing process, any of which could harm our reputation and result in a decline in revenue, each of which would harm our business. Moreover, if a product we designed or manufactured is defective, whether due to design or manufacturing defects, improper use of the product or other reasons, we may be required to notify regulatory authorities and/or to recall the product. A required notification to a regulatory authority or recall could result in an investigation by regulatory authorities of our products, which could in turn result in required recalls, restrictions on the sale of the products or other penalties. The adverse publicity resulting from any of these actions could adversely affect the perception of customers and potential customers. These investigations or recalls, especially if accompanied by unfavorable publicity, could result in our incurring substantial costs, losing revenues and damaging our reputation, each of which would harm our business.

We currently operate our business from a single location in Tucson, Arizona. Due to the lack of diversification in our assets and geographic location, an adverse development at or impacting our facility or in local or regional economic or political conditions could have a significantly greater impact on our results of operations and financial condition than if we maintained more diverse assets and locations. While we implement preventative and proactive maintenance at our facility, it is possible that we could experience prolonged periods of reduced production and increased maintenance and repair costs due to equipment failures. In addition, because of our single facility and location, in certain cases we rely on limited or single suppliers for significant inputs, such as electricity. We are also reliant on the adequacy of the local skilled labor force to support our operations. Supply interruptions to or labor shortages or stoppages at our facility could be caused by any of the aforementioned factors, many of which are beyond our control, and would adversely affect our operations and we would not have any ability to offset this concentrated impact with activities at any alternative facilities or locations.

Both our defense and commercial markets are characterized by rapidly changing technologies and evolving industry standards. Accordingly, our future performance depends on a number of factors, including our ability to identify emerging technological trends in our target markets; develop and maintain competitive products; enhance our products by improving performance and adding innovative features that differentiate our products from those of our competitors; develop and manufacture and bring products to market on-time and on-budget; and enter into suitable arrangements for volume production of mature products. We believe that, to be competitive in the future, we will need to continue to develop and commercialize technologies and products, which will require the investment of financial and engineering resources. Due to the design complexity of our products, we may in the future experience delays in completing development and introduction on a commercial scale of new products. Any delays could result in increased costs of development, deflection of resources from other projects or loss of contracts. In addition, the market for our technologies and products may not develop or expand as we currently anticipate. The failure of our technology to gain market acceptance could significantly reduce any ability to generate revenue and harm our business. Furthermore, we cannot be sure that our competitors will not develop competing or differing technologies which gain market acceptance in advance of our products. The possibility that our competitors might develop new technology or products might cause our existing technology and products to become obsolete or create significant price competition. If we fail in our new product development and commercialization efforts, or our products fail to achieve market acceptance more rapidly than our competitors, our revenue will decline and our business, financial condition and results of operations will be negatively affected. We rely on testing ranges owned and operated by third parties for outdoor testing of our technology. These outdoor testing facilities can be shut down, expensive, or offer only limited time slots for their use.

We depend heavily on information technology systems and infrastructure for our business. We, our collaborators and our service providers collect, store, and transmit sensitive information including intellectual property, proprietary business information, and research results and related data, in connection with our business operations. The secure maintenance of this information is critical to our operations and business strategy. Some of this information could be an attractive target of criminal attacks by third parties with a wide range of motives and expertise, including organized criminal groups, "hacktivists," disgruntled current or former employees, terrorist organizations, nation-state and nation-state supported actors, and others. The level of sophistication of cyber threats continues to grow over time. We have cybersecurity systems in place to protect our and our customers' proprietary information and sensitive data against the risk of inappropriate and unauthorized external use and disclosure and other types of compromise. However, these measures may prove inadequate to detect, prevent or mitigate security breaches and other incidents and we may be subject to data breaches through cyber-attacks, including ransomware, malicious code (such as viruses and worms), phishing schemes, social engineering schemes, and theft or misuse of data from inside the company. Any such breach could compromise our networks and the information stored there could be accessed, modified, destroyed, publicly disclosed, lost or stolen. If our systems become compromised, we may be unable to discover the intrusion promptly enough to mitigate any damage. A cybersecurity breach or other incident could cause our credibility to suffer with customers. Any investigation, response, or remediation of such a breach, would result in costs in addition to possibly significant legal claims or proceedings, and possibly liability under our customer contracts. Any one of these events could cause material harm to our business, results of operations and financial condition.

As we test and develop laser products, we are subject to laser safety regulations and industry standards. We are also subject to workplace regulations and safety standards for employees working with and around laser products and technology. These regulations and standards may include, among others, regulations promulgated by the US Federal Aviation Administration, the US Food and Drug Administration, the Occupational Safety and Health Administration, the Arizona Radiation and Regulatory Agency, and standards set forth by the Laser Institute of America and approved by the American National Standards Institute, Inc. (ANSI). We are also subject to various state and local safety regulations. We currently use, handle, store, and periodically dispose of relatively small quantities of chemicals used in our development process, such as acetone and isopropyl alcohol. We are subject to regulations regarding their disposal. Any increase in the type or use of such chemicals could subject us to increased regulation. We have appointed a Laser Safety Officer (LSO) who works with senior members of our scientific and engineering staff to ensure that our employees understand and follow relevant regulations and standards. However, these regulations and standards can be complex, may require specialized facilities, equipment and training, vary significantly with different laser products, processes and materials, and are subject to change from time to time (including through the adoption of more stringent EHS requirements). Our failure to comply with one or more of these regulations or standards could result in civil or criminal penalties, including significant fines or bans, liability for injury to persons or damage to property, some of which could be severe, or loss of business. In addition, future developments, such as more aggressive enforcement policies from the U.S. federal government, or the discovery of presently unknown environmental conditions, may require expenditures that could have a material adverse effect on our business, financial condition and results of operations. We may also face more stringent regulations if our operations require the use, handling, storage, transportation and disposal of hazardous materials.

A facility security clearance is required for a company to perform on classified contracts for the DoW and certain other agencies of the U.S. Government. Security clearances are subject to regulations and requirements including the National Industrial Security Program Operating Manual ("NISPOM"), which specifies the requirements for the protection of classified information released or disclosed in connection with classified U.S. Government contracts. We require certain facility and personnel security clearances to perform any anticipated classified U.S. government related business. As such, we must comply with the requirements of the NISPOM and any other applicable U.S. Government industrial security regulations. If we were to violate the terms and requirements of the NISPOM or any other applicable U.S. Government industrial security regulations (which apply to us under the terms of classified contracts), any of our cleared facilities could lose its facility security clearance. We cannot be certain that we will be able to maintain our facility security clearance. If for some reason our facility security clearance is invalidated or terminated, we would not be able to continue to perform on classified contracts and would not be able to enter into new classified contracts, which could adversely affect our ability to generate revenues. Failure to comply with the NISPOM or other security requirements may subject us to civil or criminal penalties, loss of access to classified information, inability to obtain further U.S. government contract, or potentially debarment as a government contractor

Given the highly specialized nature of our technology, the potential market for our products is limited to a relative few potential customers who tend to allocate significant budgeted amounts to selected projects. Currently, we are marketing our technology and focusing our research and development on the defense sector, in which demand is ultimately determined primarily by the US federal defense budget and the needs and priorities of the DoW and its various agencies. The potential customers in this area are defense agencies for direct contracts and major defense contractors for subcontracts. Thus, the demand for our products depends on their needs for our technology and selecting us for research and development. Although we intend to diversify into other applications for our technology and markets, we cannot be certain that opportunities in those markets will present themselves when we are ready, or that we will otherwise be able, to do so.

Our success depends on our ability to complete timely and satisfactory performance on our existing customer projects and to secure additional grants and contracts. Performance delays, cost overruns, technology failures, materials or components shortages, or contract delays, could negatively impact our business prospects, results of operations, financial condition and liquidity. U.S. government contracts generally permit the government to terminate the contract, in whole or in part, without prior notice, at the U.S. government's convenience or for default based on performance. Correspondingly, subcontracts which we may seek to enter with prime government contractors, may be terminable by the prime contractor upon government termination of the prime contract. We may be unable to secure additional contracts to offset any revenues lost as a result of the termination of any such contracts. Because the funding of U.S. government programs is subject to congressional appropriations made on a fiscal year basis even for multi-year programs, programs are often only partially funded initially and may not continue to be funded in future years. Appropriations bills may be delayed, which may result in delays to funding, the collection of receivables and our contract performance due to lack of authorized funds to procure related products and services. Under certain circumstances, we may use our own funds to meet our customers' delivery dates or other requirements, and we may not be reimbursed. If appropriations for programs are reduced or delayed, the U.S. government may terminate any contract or subcontract under that program. During the quarter ended June 30, 2025, the company received notifications regarding loss of funding on two contracts. Funding ceased for one of these contracts although it is still in effect, and no stop-work order was received. With respect to the second of these contracts, the company was notified that no further funds are available and advised to stop work on it. The company intends to continue working in parallel on this technology as part of its ongoing internal research and development program, but the company ceased recording revenue for each of these contracts, and receipt of additional amounts under them is in doubt. The growth of our business depends on the development, application and manufacture of advanced technology and products aimed at achieving challenging goals. New technologies may be untested or unproven and, in some instances, product requirements or specifications need to be developed. This could result in performance difficulties, delays, cost overruns or failures which could require additional resources to address. Any failure to execute timely and effectively on our current programs could hamper future contracting opportunities. We may also need to invest in internal research and development projects in order to achieve certain grants or contracts, as our customers may demand proven concepts and solutions. These expenditures may not pay off if we are not awarded the intended grants or contracts. Under certain types of government contracts, if we are unable to control costs or if our initial cost estimates are incorrect, our profitability could be negatively affected, particularly under fixed-price development contracts. We may also experience cost underruns which would reduce contract value and related expected revenues, and we may be unable to expand the contract scope or secure additional work to offset the resulting lost revenues. Contracts for development programs with complex design and technical challenges may be cost reimbursable. However, if they are firm fixed price or fixed price incentive contracts, such challenges and unexpected cost increases may impact our results of operations. US government contracts also require compliance with extensive and evolving procurement and other rules and regulations and subject us to potential audits, investigations, and disputes. We may also become involved in programs that are classified or otherwise restricted by the US government, which place limits on our ability to discuss our performance on these programs, including any risks, disputes and claims.