Notes to Consolidated Financial Statements (Unaudited)
March 31, 2023 and 2022
Note 1: Nature of Operations
Castellum, Inc. (the “Company”) is focused on acquiring and growing technology companies in the areas of information technology, electronic warfare, information warfare and cybersecurity with businesses in the governmental and commercial markets. Services include intelligence analysis, software development, software engineering, program management, strategic planning, information assurance and cybersecurity and policy along with analysis support. These services, which largely focus on securing data and establishing related policies, are applicable to customers in the federal government, financial services, healthcare and other users of large data applications. The services can be delivered to legacy, customer owned networks or customers who rely upon cloud-based infrastructures. The Company has worked with multiple business brokers and contacts within its business network to identify potential acquisitions.
Since November 2019, the Company has made the following acquisitions that specialize in the areas noted above:
•Corvus Consulting, LLC (“Corvus”),
•Mainnerve Federal Services, Inc. dba MFSI Government Group (“MFSI),
•Merrison Technologies, LLC (“Merrison”),
•Specialty Systems, Inc. (“SSI”),
•the business assets of Pax River from The Albers Group (“Pax River”), and
•Lexington Solutions Group, LLC (“LSG”).
•Global Technology and Management Resources, Inc. ("GTMR")
With the exception of Pax River, all of these acquisitions were considered business combinations under Topic 805 Business Combinations of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”). See Note 3, “Acquisitions” for greater details on the acquisitions of the Company since January 1, 2022.
On October 17, 2022, the Company completed a $3,000,000 public offering, a 1-for-20 Reverse Stock Split of its common shares, and an uplisting to the NYSE American exchange. All share and per share figures related to the common stock have been retroactively adjusted in accordance with SEC Staff Accounting Bulletin (“SAB”) Topic 4C.
Note 2: Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements, including the notes, include the accounts of the Company and its wholly-owned subsidiaries and have been prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") and the rules and regulations of the U.S. Securities and Exchange Commission ("SEC"). All intercompany balances and transactions have been eliminated in consolidation.
Basis of Presentation for Interim Periods
Certain information and footnote disclosures normally included for the annual financial statements prepared in accordance with U.S. GAAP have been condensed or omitted for the interim periods presented. We believe that the unaudited interim financial statements include all adjustments (which are normal and recurring in nature) necessary to present fairly our financial position and the results of operations and cash flows for the periods presented.
The results of operations for the interim periods presented are not necessarily indicative of results that may be expected for the year or future periods. The financial statements should be read in conjunction with our audited consolidated financial statements and the notes thereto for the year ended December 31, 2022 included in our Annual Report on Form 10-K for the year then ended. We have continued to follow the accounting policies set forth in those financial statements.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and reported amounts of
revenues and expenses during the reporting period. These estimates include, but are not limited to, management’s estimate of provisions required for uncollectible accounts receivable, the acquired value of the intangible assets, impaired value of intangible assets, liabilities to accrue, cost incurred in the satisfaction of performance obligations, fair value for consideration elements of business combinations, permanent and temporary differences related to income taxes and determination of the fair value of stock awards. Actual results could differ from those estimates.
Revenue Recognition
The Company accounts for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers.
The Company accounts for a contract with a customer that is within the scope of this Topic only when the five steps of revenue recognition under ASC 606 are met.
The five core principles will be evaluated for each service provided by the Company and is further supported by applicable guidance in ASC 606 to support the Company’s recognition of revenue.
Revenue is derived primarily from services provided to the Federal government. The Company enters into agreements with customers that create enforceable rights and obligations and for which it is probable that the Company will collect the consideration to which it will be entitled as services and solutions are transferred to the customer. The Company also evaluates whether two or more agreements should be accounted for as one single contract.
When determining the total transaction price, the Company identifies both fixed and variable consideration elements within the contract. The Company estimates variable consideration as the most likely amount to which the Company expects to be entitled limited to the extent that it is probable that a significant reversal will not occur in a subsequent period.
At contract inception, the Company determines whether the goods or services to be provided are to be accounted for as a single performance obligation or as multiple performance obligations. For most contracts, the customers require the Company to perform several tasks in providing an integrated output and, hence, each of these contracts are deemed as having only one performance obligation. When contracts are separated into multiple performance obligations, the Company allocates the total transaction price to each performance obligation based on the estimated relative standalone selling prices of the promised services underlying each performance obligation.
This evaluation requires professional judgment, and it may impact the timing and pattern of revenue recognition. If multiple performance obligations are identified, the Company generally uses the cost plus a margin approach to determine the relative standalone selling price of each performance obligation. The Company does not assess whether a contract contains a significant financing component if the Company expects, at contract inception, that the period between when payment by the client and the transfer of promised services to the client occur will be less than one year.
The Company currently generates its revenue from three different types of contractual arrangements: cost plus fixed fee (“CPFF”), firm-fixed-price contracts (“FFP”) and time-and-materials (“T&M”) contracts. The Company generally recognizes revenue over time as control is transferred to the customer, based on the extent of progress towards satisfaction of the performance obligation. The selection of the method used to measure progress requires judgment and is dependent on the contract type and the nature of the goods or services to be provided.
For CPFF contracts, the Company uses input progress measures to derive revenue based on hours worked on contract performance as follows: direct costs plus Defense Contract Audit Agency (“DCAA”) approved provisional burdens plus fee. The provisional indirect rates are adjusted and billed at actual at year end. Revenue from FFP contracts is generally recognized ratably over the contract term, using a time-based measure of progress, even if billing is based on other metrics or milestones, including specific deliverables. For T&M contracts, the Company uses input progress measures to estimate revenue earned based on hours worked on contract performance at negotiated billing rates, plus direct costs and indirect cost burdens associated with materials and the direct expenses incurred in performance of the contract.
These arrangements generally qualify for the “right-to-invoice” practical expedient where revenue is recognized in proportion to billable consideration. FFP Level-Of-Effort contracts are substantially similar to T&M contracts except that the Company is required to deliver a specified level of effort over a stated period. For these contracts, the Company estimates revenue earned using contract hours worked at negotiated bill rates as the Company delivers the contractually required workforce.
Revenue generated by Contract Support Service contracts is recognized over time as services are provided, based on the transfer of control. Revenue generated by FFP contracts is recognized over time as performance obligations are satisfied. Most contracts do not contain variable consideration and contract modifications are generally minimal. For these reasons, there is not a significant impact of electing these transition practical expedients.
Revenue generated from contracts with Federal, state, and local governments is recorded over time, rather than at a point in time. Under the Contract Support Services contracts, the Company performs software design work as it is assigned by the customer, and bills the customer, generally semi-monthly, on either a CPFF or T&M basis, as labor hours are expended. Certain other government contracts for software development have specific deliverables and are structured as FFP contracts, which are generally billed as the performance obligations under the contract are met. Revenue recognition under FFP contracts require judgment to allocate the transaction price to the performance obligations. Contracts may have terms up to five years.
Contract accounting requires judgment relative to assessing risks and estimating contract revenue and costs and assumptions for schedule and technical issues. Due to the size and nature of contracts, estimates of revenue and costs are subject to a number of variables. For contract change orders, claims or similar items, judgment is required for estimating the amounts, assessing the potential for realization and determining whether realization is probable. Estimates of total contract revenue and costs are continuously monitored during the term of the contract and are subject to revision as the contract progresses. From time to time, facts develop that require revisions of revenue recognized or cost estimates. To the extent that a revised estimate affects the current or an earlier period, the cumulative effect of the revision is recognized in the period in which the facts requiring the revision become known.
The Company accounts for contract costs in accordance with ASC Topic 340-40, Contracts with Customers. The Company recognizes the cost of sales of a contract as expense when incurred or at the time a performance obligation is satisfied. The Company recognizes an asset from the costs to fulfill a contract only if the costs relate directly to a contract, the costs generate or enhance resources that will be used in satisfying a performance obligation in the future and the costs are expected to be recovered. The incremental costs of obtaining a contract are capitalized unless the costs would have been incurred regardless of whether the contract was obtained.
The following table disaggregates the Company’s revenue by contract type for the three months ended March 31:
| | | | | | | | | | | |
| 2023 | | 2022 |
| Revenue: | | | |
| Time and material | $ | 5,723,610 | | | $ | 4,884,186 | |
| Firm fixed price | 943,875 | | | 1,774,092 | |
| Cost plus fixed fee | 3,269,528 | | | 3,331,863 | |
| | | |
| Total | $ | 9,937,013 | | | $ | 9,990,141 | |
Recent Accounting Pronouncements
The Company does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its financial condition, results of operations, cash flows, or disclosures. There have been no recently issued accounting pronouncements as of March 31, 2023 that would materially impact the company.
Note 3: Acquisitions
The Company has completed the following acquisitions to achieve its business purposes as discussed in Note 1. As the acquisitions made by the Company in 2022 and 2023 were of the common stock or membership interests of the companies, certain assets in some of the acquisitions (intangible assets and goodwill) are not considered deductible for tax purposes.
GTMR
On March 22, 2023, the Company entered into an agreement and plan of merger with GTMR. This acquisition was accounted for as a business combination whereby GTMR became a 100% owned subsidiary of the Company. The
Company acquired GTMR to expand our capabilities, increase market share, gain access to new contracts, and achieve cost efficiencies through synergies and economies of scale.
The following represents the preliminary assets and liabilities acquired in this acquisition:
| | | | | |
| Cash | $ | 475,000 | |
| Accounts receivable other receivables | 1,380,203 | |
| Income tax receivable | 155,449 | |
| Prepaid expenses | 116,892 | |
| Other asset | 17,182 | |
| Furniture and equipment | 163,301 | |
| |
| Customer relationships | 2,426,000 | |
| |
| Tradenames | 517,000 | |
| Backlog | 1,774,000 | |
| Goodwill | 1,822,466 | |
| Deferred tax liability | (1,244,368) | |
| Lease liability – operating lease | (17,608) | |
| |
| Accounts payable and accrued expenses | $ | (1,030,957) | |
| Net assets acquired | $ | 6,554,560 | |
The consideration paid for GTMR was as follows:
| | | | | |
| Cash | $ | 470,233 | |
| Due to Seller | 350,000 | |
| Other consideration | 17,791 | |
| Cash from factoring | 411,975 | |
| Stock | $ | 5,304,561 | |
| Total consideration paid | $ | 6,554,560 | |
The GTMR acquisition has been accounted for under the acquisition method of accounting. Under the acquisition method of accounting, the total acquisition consideration price was allocated to the assets acquired and liabilities assumed based on their preliminary estimated fair values. The fair value measurements utilize estimates based on key assumptions of the GTMR acquisition, and historical and current market data. The excess of the purchase price over the total of the estimated fair values assigned to tangible and identifiable intangible assets acquired and liabilities assumed is recognized as goodwill. To determine the fair values of tangible and intangible assets acquired and liabilities assumed for GTMR, we have engaged a third-party independent valuation specialist. On the date of the acquisition, the Company simultaneously factored $411,975 of the accounts receivable from GTMR to finance the acquisition.
The Company had received a preliminary valuation from its specialist and recorded the value of the assets and liabilities acquired based on historical inputs and data as of March 22, 2023. The allocation of the purchase price is based on the best information available. The Company paid $185,896 in transaction costs of GTMR.
During the measurement period (which is the period required to obtain all necessary information that existed at the acquisition date, or to conclude that such information is unavailable, not to exceed one year), additional assets or liabilities may be recognized, or there could be changes to the amounts of assets or liabilities previously recognized on a preliminary basis, if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of these assets or liabilities as of that date. The measurement period for the GTMR acquisition is currently open and may remain open until March 22, 2024.
LSG
On April 15, 2022, the Company entered into Amendment No. 1 to Business Acquisition Agreement (“LSG Business Acquisition Agreement”) with LSG to acquire the assets of LSG. The Company acquired LSG to expand our capabilities, increase market share, gain access to new contracts, and achieve cost efficiencies through synergies and economies of scale. This LSG Business Acquisition Agreement superseded the Business Acquisition Agreement originally entered into on February 11, 2022. Under the terms of the LSG Business Acquisition Agreement, the Company acquired assets and assumed liabilities of LSG for consideration as follows: (a) 625,000 shares of common stock (600,000 shares paid at closing (issued on May 4, 2022) and 25,000 shares to be held and due within three business days of payment of the second tranche of cash described below); and (b) cash payments as follows: $250,000 due at closing (“initial cash payment”); $250,000 plus or minus any applicable post-closing adjustments paid on the date that is six months after the closing date (“second tranche”) (paid in October 2022); and $280,000 that was due no later than 10 months after the closing date of the acquisition (this amount was paid in January 2023).
The following represents the assets and liabilities acquired in this acquisition:
| | | | | |
| Receivable from seller | $ | 413,609 | |
| Due from employee/travel advance | 5,000 | |
| Miscellaneous license | 2,394 | |
| Customer relationships | 785,000 | |
| Non-compete agreements | 10,000 | |
| Backlog | 489,000 | |
| Goodwill | 1,471,000 | |
| Net assets acquired | $ | 3,176,003 | |
The consideration paid for the acquisition of LSG was as follows:
| | | | | |
Common stock (600,000 shares issued May. 4, 2022) | $ | 2,280,000 | |
Holdback shares (25,000 shares due six months after the closing date) | 95,000 | |
| Cash | 250,000 | |
| Due to seller (cash) | 551,003 | |
| $ | 3,176,003 | |
The LSG acquisition has been accounted for under the acquisition method of accounting. Under the acquisition method of accounting, the total acquisition consideration price was allocated to the assets acquired and liabilities assumed based on their preliminary estimated fair values. The fair value measurements utilize estimates based on key assumptions of the LSG acquisition, and historical and current market data. The excess of the purchase price over the total of the estimated fair values assigned to tangible and identifiable intangible assets acquired and liabilities assumed is recognized as goodwill. To determine the fair values of tangible and intangible assets acquired and liabilities assumed for LSG, we engaged a third-party independent valuation specialist.
The Company had received a valuation from its specialist and recorded the value of the assets and liabilities acquired based on historical inputs and data as of April 15, 2022. The allocation of the purchase price is based on the best information available. The Company paid $44,752 in transaction costs of LSG.
During the measurement period (which is the period required to obtain all necessary information that existed at the acquisition date, or to conclude that such information is unavailable, not to exceed one year), additional assets or liabilities may be recognized, or there could be changes to the amounts of assets or liabilities previously recognized on a preliminary basis, if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of these assets or liabilities as of that date. There have been no adjustments in the three months ended March 31, 2023 and we do not intend to include any additional adjustments through the remainder of the measurement period.
For all acquisitions disclosed, there were no transaction costs that were not recognized as an expense.
The following table shows unaudited pro-forma results for the three months ended March 31, 2023 and 2022, as if the acquisitions of LSG and GTMR had occurred on January 1, 2022. These unaudited pro forma results of operations are based on the historical financial statements of each of the companies.
| | | | | |
| For the three months ended March 31, 2023 | |
| Revenues | $ | 12,583,985 | |
| Net loss | $ | (6,532,634) | |
| Net loss per share - basic | $ | (0.16) | |
| For the three months ended March 31, 2022 | |
| Revenues | $ | 13,932,618 | |
| Net loss | $ | (961,653) | |
| Net loss per share - basic | $ | (0.05) | |
Note 4: Fixed Assets
Fixed assets consisted of the following as of March 31, 2023 (unaudited) and December 31, 2022:
| | | | | | | | | | | |
| March 31, 2023 | | December 31, 2022 |
| Equipment | $ | 210,572 | | | $ | 141,732 | |
| Furniture | 40,267 | | | 32,574 | |
| Software | 62,671 | | | - | |
| Leasehold improvements | 120,830 | | | 83,266 | |
| Total fixed assets | 434,340 | | | 257,572 | |
| Accumulated depreciation | (97,098) | | | (84,222) | |
| Fixed assets, net | $ | 337,242 | | | $ | 173,350 | |
Depreciation expense for the three months ended March 31, 2023, and 2022 was $19,936 and $13,484, respectively.
Note 5: Intangible Assets and Goodwill
Intangible assets consisted of the following as of March 31, 2023 and December 31, 2022:
| | | | | | | | | | | | | | | | | |
| | | March 31,
2023 | | December 31,
2022 |
| Customer relationships | 4.5– 15 years | | $ | 11,961,000 | | | $ | 9,535,000 | |
| Tradename | 4.5 years | | 783,000 | | | 266,000 | |
| Trademark | 10-15 years | | 533,864 | | | 533,864 | |
| Backlog | 2-5 years | | 3,210,000 | | | 1,436,000 | |
| Non-compete agreement | 3-5 years | | 684,000 | | | 684,000 | |
| | | 17,171,864 | | | 12,454,864 | |
| Accumulated amortization | | | (6,311,329) | | | (5,820,697) | |
| Intangible assets, net | | | $ | 10,860,535 | | | $ | 6,634,167 | |
The intangible assets with the exception of the trademarks were recorded as part of the acquisitions of Corvus, MFSI, Merrison, SSI, LSG, and GTMR. Amortization expense for the three months ended March 31, 2023 and 2022, was $490,631 and $1,123,590, respectively, and the intangible assets are being amortized based on the estimated future lives as noted above. On March 31, 2022, $275,000 of customer relationships was adjusted for the contingent consideration that is no longer required to be paid for the acquisition related to The Albers Group.
Future amortization of the intangible assets for the next five years as of March 31 are as follows:
| | | | | |
| 2023 | $ | 1,889,671 | |
| 2024 | 2,074,686 | |
| 2025 | 1,453,000 | |
| 2026 | 1,242,863 | |
| 2027 | 1,034,302 | |
| Thereafter | 3,166,013 | |
| Total | $ | 10,860,535 | |
The activity of goodwill for the three months ended March 31, 2023 and year ended December 31, 2022, is as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Corvus | | SSI | | MFSI | | Total |
| December 31, 2022 | 6,387,741 | | | 8,461,150 | | | 685,073 | | | 15,533,964 | |
| Goodwill acquired through acquisitions | — | | | 1,822,466 | | | — | | | 1,822,466 | |
| March 31, 2023 | 6,387,741 | | | 10,283,616 | | | 685,073 | | | 17,356,430 | |
When the Company acquires a controlling financial interest through a business combination, the Company uses the acquisition method of accounting to allocate the purchase consideration to the assets acquired and liabilities assumed, which are recorded at fair value. Any excess of purchase consideration over the net fair value of the net assets acquired is recognized as goodwill. The additions of goodwill in the respective periods relate to the acquisitions made by the Company. The Company has not disposed of any entities, nor has the Company recognized impairment on the goodwill in these periods.
Note 6: Convertible Promissory Notes – Related Parties
The Company entered into convertible promissory notes – related parties as follows as of March 31, 2023 and December 31, 2022:
| | | | | | | | | | | |
| March 31,
2023 | | December 31,
2022 |
Convertible note payable with a trust related to one of the Company’s directors, convertible at $0.26 per share, at 5% interest (amended April 4, 2022) | 3,209,617 | | | 3,209,617 | |
| | | |
| Less: BCF Discount | (1,910,444) | | | (2,210,187) | |
| $ | 1,299,173 | | | $ | 999,430 | |
Interest expense which includes amortization of discount for the three months ended March 31, 2023 and 2022 was $340,120 and $417,219, respectively. There was no accrued interest on the note payable at March 31, 2023. The amount of the BCF discount recorded was evaluated for characteristics of liability or equity and was determined to be equity under ASC 470 and ASC 480. The Company recognized this as additional paid in capital, and the discount is being amortized over the life of the note.
The entire convertible promissory note – related parties balance is reflected in long-term liabilities.
Note 7: Notes Payable
The Company entered into notes payable as follows as of March 31, 2023 and December 31, 2022:
| | | | | | | | | | | |
| March 31, 2023 | | December 31,
2022 |
Note payable at 7% originally due November 2023, maturing September 30, 2024 | $ | 5,600,000 | | | $ | 5,600,000 | |
Note payable at 10% interest dated February 28, 2022 and matures the earlier of (i) September 30, 2024 or (ii) the acceleration of the obligations as contemplated under the promissory note including the successful completion of an equity offering of at least $15,000,000 (a) | 400,000 | | | 400,000 | |
Convertible note payable, convertible at $1.60 per share, at 7%, maturing April 4, 2023 (b) | — | | | 890,000 | |
Convertible note payable, convertible at $1.20 per share, at 10%, maturing February 13, 2024 (b) | 840,000 | | | — | |
Term note payable, at prime plus 3% interest, applied on a deferred basis (7.75% at March 31, 2023 and 6.25% at December 31, 2022) maturing August 11, 2024 | 2,010,245 | | | 2,324,236 | |
| | | |
| Total Notes Payable | 8,850,245 | | | 9,214,236 | |
| Less: Debt Discount | (911,162) | | | (840,398) | |
| $ | 7,939,083 | | | $ | 8,373,838 | |
(a)On February 28, 2022, the Company was obligated to issue 125,000 shares of common stock as further consideration for making this loan to the Company. The shares were issued in April 2022.
(b)On February 13, 2023, the Company entered into a series of transactions with Crom Cortana Fund LLC (“Crom”), the primary purpose of which is related to the GTMR acquisition entered into on March 22, 2023. In connection therewith, the Company and Crom entered into an agreement to pay off the amount owed to Crom under the terms of the convertible promissory note in the original principal amount of $1,050,000 due April 4, 2023 ("Prior Crom Note"). In consideration of a $300,000 cash payment and 556,250 shares of common stock representing conversion of the remaining principal balance of the Company’s obligations under the Prior Crom Note are deemed satisfied reducing the balance to zero; we induced conversion of the debt, which effectively extinguished the debt. Simultaneously therewith, the parties entered into the Securities Purchase Agreement (the “2023 SPA”) pursuant to which Crom purchased (a) a convertible promissory note in the principal amount of $840,000 (the “2023 Note Payable”), which matures February 13, 2024 and bears interest at a per annum rate equal to 10% to be paid monthly, and (b) a warrant pursuant to which Crom has the right to purchase up to 700,000 shares of the Company’s common stock (the “2023 Warrant”) at an exercise price of $1.38 which expire 60 months from the date of issuance. The proceeds of the 2023 Note Payable were used primarily to fund the GTMR acquisition, as well as fund the aforementioned debt repayment.
Interest expense which includes amortization of discount for the three months ended March 31, 2023 and 2022 was $485,000 and $268,576, respectively. Accrued interest on the notes payable as of March 31, 2023 is $16,388.
Each note discussed above will reach maturity during 2024. Future principal payments will be $1,046,796 and $7,803,449 in 2023 and 2024, respectively.
Note 8: Note Payable – Related Party
The Company entered into a note payable with a related party in August 2021 with balances as of March 31, 2023 (unaudited) and December 31, 2022, as follows:
| | | | | | | | | | | |
| March 31,
2023
(unaudited) | | December 31,
2022 |
Note payable at 5% due December 31, 2024, in connection with the acquisition of SSI | $ | 400,000 | | | $ | 400,000 | |
Interest expense for the three months ended March 31, 2023 and 2022 was $4,928 and $4,928, respectively. The entire note payable – related party balance is reflected in noncurrent liabilities.
Note 9: Revolving Credit Facility
On April 4, 2022, the Company secured a $950,000 revolving credit facility with Live Oak Bank (“Revolving Credit Facility”). The Revolving Credit Facility matures on March 28, 2029, and draws on it are charged interest at the rate of prime plus 2.75% per annum. Interest is payable monthly. On April 12, 2022, the Company was advanced $300,025 under the Revolving Credit Facility. The Company incurred $19,351 in interest in the three months ended March 31, 2023, of which $11,971 is accrued for as of March 31, 2023.
Note 10: Due to Seller
In the acquisition of LSG, the Company was obligated to pay $3,176,003, which included cash of $780,000 and a working capital adjustment of $21,003. Of this amount, $521,003 was paid by December 31, 2022. The remaining $280,000 of this balance was paid on January 23, 2023.
In the acquisition of GTMR, the Company was obligated to pay $1,250,000 which included $350,000 held back to satisfy any net working capital deficiencies. This balance is scheduled to be paid six months following the closing date and is currently recorded in current liabilities on the Company's consolidated balance sheets as of March 31, 2023.
Note 11: Stockholders’ Equity
On October 13, 2022, the Company effected a 1-for-20 reverse split ("Reverse Stock Split") of our authorized and outstanding shares of common stock. As a result of the Reverse Stock Split, all authorized and outstanding common stock and per share amounts in this Quarterly Report on Form 10-Q, including but not limited to, the consolidated financial statements and footnotes included herein, have been adjusted to reflect the Reverse Stock Split for all periods presented.
Preferred Stock
The Company has 50,000,000 shares of preferred stock authorized. The Company has designated a Series A Preferred Stock, Series B Preferred Stock, and a Series C Preferred Stock.
Series A Preferred Stock
The Company has designated 10,000,000 shares of Series A Preferred Stock, par value of $0.0001. As of March 31, 2023 and December 31, 2022, the Company has 5,875,000 shares of Series A Preferred Stock issued and outstanding.
For the three months ended March 31, 2023, the Company recognized $18,269 in Series A dividends, all of which has been paid as of March 31, 2023.
Series B Preferred Stock
The Company has designated 10,000,000 shares of Series B Preferred Stock, par value of $0.0001. As of March 31, 2023 and December 31, 2022, the Company has 0 shares of Series B Preferred Stock issued and outstanding.
Series C Preferred Stock
The Company has designated 10,000,000 shares of Series C Preferred Stock, par value of $0.0001. As of March 31, 2023 and December 31, 2022, the Company has 770,000 shares of Series C Preferred Stock issued and outstanding.
For the three months ended March 31, 2023, the Company recognized $12,050 in Series C dividends, all of which has been paid as of March 31, 2023.
Common Stock
The Company has 3,000,000,000 shares of common stock, par value $0.0001 authorized. The Company has 47,247,687 and 41,699,363 shares issued and outstanding as of March 31, 2023 and December 31, 2022, respectively. Shares issued during the three months ended March 31, 2023 were as follows:
•The Company issued 125,504 shares for services;
•4,866,570 shares issued in the acquisition of GTMR;
•556,250 shares issued to extinguish the Prior Crom Note.
During the three months ended March 31, 2023, the Company issued 314,600 restricted shares of common stock, that vest ratably over a period of one year, to its Board of Directors for their service. Any unvested restricted shares of common stock are forfeited upon termination. As of March 31, 2023, there were 125,504 total restricted shares of common stock that have vested and 189,096 that will vest during the remainder of 2023.
Warrants
The following represents a summary of warrants for the three months ended March 31, 2023 and the year ended December 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended
March 31, 2023 | | Year Ended
December 31, 2022 |
| Number | | Weighted
Average
Exercise
Price | | Number | | Weighted
Average
Exercise
Price |
| Beginning balance | 5,678,836 | | $ | 1.84 | | | 3,161,568 | | $ | 1.60 | |
| Granted | 1,765,862 | | 1.17 | | | 2,517,268 | | 2.22 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| Ending balance | 7,444,698 | | $ | 1.68 | | | 5,678,836 | | $ | 1.84 | |
| | | | | | | |
| Warrants exercisable | 7,444,698 | | | | 5,678,836 | | |
| Intrinsic value of warrants | $ | 1,242,174 | | | | | $ | 1,374,303 | | | |
| Weighted Average Remaining Contractual Life (Years) | 6.15 | | | | 5.48 | | |
During the three months ended March 31, 2023, the Company granted 1,065,862 warrants to two of its officers at $1.04 per share that expire on March 22, 2030. The warrants were issued as part of a bonus achieved under the respective employment agreements for two of the officers of the Company. The Company also granted 700,000 warrants to Crom, as part of the debt transaction discussed in Note 7, at $1.38 per share that expire on February 13, 2028.
All of the warrants have been fully expensed through March 31, 2023.
Options
The Company on November 9, 2021, approved the Stock Incentive Plan, that authorizes the Company to grant up to 2,500,000 shares. Prior to this date, the granting of options was not done in accordance with a stock option plan. As of March, 31, 2023 812,500 stock options have been granted under the Stock Incentive Plan.
The following represents a summary of options for the three months ended March 31, 2023 and the year ended December 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | |
| Number | | Weighted
Average
Exercise
Price | | Weighted-Average Remaining Contractual Term (in Years) | | Weighted
Average
Fair Value |
| Outstanding, December 31, 2022 | 6,425,000 | | $ | 2.69 | | | 5.63 | | $ | 4.26 | |
| Granted | 812,500 | | 1.62 | | | 6.84 | | 1.10 | |
| Outstanding. March 31, 2023 | 7,237,500 | | $ | 2.57 | | | 5.55 | | $ | 3.91 | |
| | | | | | | |
| As of March 31, 2023 | | | | | | | |
| Vested and exercisable | 3,178,870 | | $ | 2.24 | | | 5.21 | | $ | 3.20 | |
| | | | | | | |
The fair value of each option/warrant is estimated using the Black-Scholes valuation model. Changes to these inputs could produce a significantly higher or lower fair value measurement. The following assumptions were used for the periods as follows:
| | | | | | | | | | | |
| Three Months
Ended
March 31,
2023 | | Year
Ended
December 31, 2022 |
| Expected term | 7 years | | 7 years |
| Expected volatility | 116 – 162% | | 114 – 157% |
| Expected dividend yield | — | | | — | |
| Risk-free interest rate | 3.53 – 3.89% | | 2.00% - 4.18% |
Note 12: Fair Value
Fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. GAAP sets forth a three-level fair value hierarchy, which prioritizes the inputs used in measuring fair value. The three levels are as follows:
Level 1 – defined as observable inputs, such as quoted market prices in active markets.
Level 2 – defined as inputs other than quoted prices in active markets that are either directly or indirectly observable.
Level 3 – defined as unobservable inputs in which little or no market data exists, therefore, requiring an entity to develop its own assumptions.
Our financial assets and liabilities subject to the three-level fair value hierarchy consist principally of cash and cash equivalents, accounts receivable, accounts payable, contingent consideration and derivative liabilities. The estimated fair value of cash and cash equivalents, accounts receivable, and accounts payable approximates their carrying value.
The Company issued common stock, a convertible note, and warrants in a SPA with Crom (“Derivative Liabilities”) in 2022. During the three months ended March 31, 2023, the Company terminated this note through an induced conversion and extinguished the conversion option liability associated with the Prior Crom Note. As part of this transaction, the Company entered into another note with Crom and issued common stock, a convertible note, and warrants in this SPA. The Company evaluated the conversion option in the convertible note and the warrants to determine proper accounting treatment and determined them to be Derivative Liabilities. The Derivative Liabilities identified have been accounted for utilizing ASC 815 “Derivatives and Hedging.” The Company has incurred a liability for the estimated fair value of Derivative Liabilities. The estimated fair value of the Derivative Liabilities has been calculated using a binomial pricing model with key input variables by an independent third party, as of the date of issuance, with changes in fair value recorded as gains or losses on revaluation in other income (expense).
The contingent earnout included in total consideration for the SSI acquisition, included in current liabilities on the Consolidated Balance Sheets, is measured at fair value on a recurring basis using the present value approach, which incorporates factors such as revenue growth and forecasted adjusted EBITDA to estimate expected value. Changes in fair value of the contingent earnout are recorded as gains or losses on revaluation in other income (expense) on the Consolidated Statements of Operations.
The Company determined that the significant inputs used to value the Derivative Liabilities and the contingent earnout fall within Level 3 of the fair value hierarchy. As a result, the Company has determined that the valuation of its Derivative Liabilities and contingent earnout are classified in Level 3 of the fair value hierarchy as shown in the table below:
| | | | | | | | | | | | | | | | | | | | | | | |
| Fair Value Measurements at March 31, 2023 |
| Level 1 | | Level 2 | | Level 3 | | Total |
| Crom Derivative Liabilities | $ | — | | | $ | — | | | $ | 421,000 | | | $ | 421,000 | |
| Prior Crom Note warrant liability | $ | — | | | $ | — | | | $ | 539,000 | | | $ | 539,000 | |
| Contingent earnout | $ | — | | | $ | — | | | $ | 794,000 | | | $ | 794,000 | |
| Total | $ | — | | | $ | — | | | $ | 1,754,000 | | | $ | 1,754,000 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Fair Value Measurements at December 31, 2022 |
| Level 1 | | Level 2 | | Level 3 | | Total |
| Crom Derivative Liabilities | $ | - | | | $ | - | | | $ | 824,000 | | | $ | 824,000 | |
| Contingent earnout | $ | - | | | $ | - | | | $ | 812,000 | | | $ | 812,000 | |
| Total | $ | - | | | $ | - | | | $ | 1,636,000 | | | $ | 1,636,000 | |
The Company’s derivative liabilities as of March 31, 2023 and December 31, 2022 associated with the Derivative Liabilities are as follows.
| | | | | | | | | | | | | | | | | |
| March 31, 2023 | | December 31,
2022 | | Inception |
| Fair value of conversion option of Prior Crom note | $ | — | | | $ | 191,000 | | | $ | 314,000 | |
Fair value of 656,250 warrants on April 4, 2022 | 539,000 | | | 633,000 | | | 378,000 | |
| Fair value of conversion option of Crom Cortana Fund LLC convertible note | 162,000 | | | — | | | 162,000 | |
Fair value of 700,000 warrants on February 13, 2023 | 259,000 | | | — | | | 259,000 | |
| $ | 960,000 | | | $ | 824,000 | | | |
Changes to these inputs could produce a significantly higher or lower fair value measurement. The fair value of each Derivative Instrument is estimated using a binomial valuation model. The following assumptions were used for the periods as follows:
| | | | | |
| 3/31/2023 |
| Expected term – conversion option | 1 year |
| Expected term - warrants | 5 years |
| Stock price as of measurement date | $ | 1.12 | |
| Equity volatility - unadjusted | 131.90 | % |
| Volatility haircut | 5.00 | % |
| Selected volatility – post haircut | 124.20 | % |
| Senior unsecured synthetic credit rating | CCC+ |
| OAS differential between CCC+ and B- bonds | 1047bps |
| Risk-free interest rate | 4.90 | % |
Note 13: Concentrations
Concentration of Credit Risk. The Company’s customer base is concentrated with a relatively small number of customers. The Company does not generally require collateral or other security to support accounts receivable. To reduce credit risk, the Company performs ongoing credit evaluations on its customers’ financial condition. The Company establishes allowances for doubtful accounts based upon factors surrounding the credit risk of customers, historical trends, and other information.
For the three months ended March 31, 2023 and 2022, the Company had three customers representing 60% and 70% of revenue earned, respectively. Any customer that represents 10% or greater of total revenue represents a risk. The Company also has four customers that represent 38% and 60% of the total accounts receivable as of March 31, 2023 and December 31, 2022, respectively.
Note 14: Commitments
As part of the acquisition of GTMR, the Company entered into an employment agreement with the GTMR Chief Executive Officer (the "Executive") on March 22, 2023 for a three year term. During the term of the employment agreement, the Company shall pay the Executive an annual base salary of $200,000 (the “Base Salary”). The Base Salary shall be payable to the Executive during the term in substantially equal installments in accordance with the Company’s customary payroll practices. The Executive, as of the date of the acquisition, was awarded an incentive stock option to purchase 300,000 shares of the the Company’s Common Stock (the “Options”). The Executive is also eligible to receive an annual bonus (the “Annual Bonus”) in fiscal year 2023 which, provided GTMR obtains a net profit above $1,000,000 (the “Threshold”), shall be awarded in an amount equal to $0.25 for every $1 above the Threshold up to a net profit of $2,000,000. The Annual Bonus amount payable to the Executive for fiscal year 2023 shall not exceed $250,000.
Note 15: Income Taxes
The Company's quarterly provision for income taxes is measured using an estimated annual effective tax rate adjusted for discrete items that occur within the quarter. The provision for income taxes was a benefit of $1,225,649 and $149,628 for the three months ended March 31, 2023 and 2022, respectively. The effective income tax rate was 22.1% and 9.7% for the three months ended March 31, 2023 and 2022, respectively. The increase in the effective tax rate was primarily due to the release of a valuation allowance against the Company's net deferred tax assets. The Company recognized a discrete tax benefit of $1,244,368 for the release of the valuation allowance due to the increase in deferred tax liabilities that related to the GTMR acquisition in the period ended March 31, 2023.
As of March 31, 2023, the Company had a valuation allowance of $1,458,722 primarily related to the Company’s deferred tax assets that are more likely than not will not be realized.
Note 16: Factoring of Accounts Receivable
On January 24, 2023, GTMR (acquired by the Company on March 22, 2023 and discussed in Note 3) entered into a factoring agreement (the “Factoring Agreement”) with Republic Capital Access LLC (“RCA”) wherein the GTMR agreed to sell certain of its accounts receivable, up to a limit of $1,000,000 without recourse.
During the three months ended March 31, 2023, total receivables sold under the Factoring Agreement was $484,677. Without recourse indicates that the Company assigns and transfers its rights, title, and interest in and to the accounts receivable to RCA, meaning that the Company will not be liable to repay all or any portion of the advance amount if any portion of the accounts receivable is not paid by the Company’s customer(s). Information on accounts receivable identified for factoring are provided and verified by RCA prior to being accepted for factoring. Pursuant to the Factoring Agreement, the Company will receive an initial payment of 90% or 85% on prime contracts or subcontracts, respectively. The remaining balance of the receivable is paid upon receipt of payment by RCA, less RCA factoring fees.
The Company pays factoring fees associated with the sale of receivables based on the dollar value of the receivables sold. Factoring fees paid under this arrangement were $0 for the three months ended March 31, 2023.
Note 17: Subsequent Events
As disclosed previously, on January 18, 2023, the Company had signed a non-binding letter of intent to acquire an East Coast based government contractor. Subsequent to March 31, 2023, the Company determined that it is not currently pursuing this acquisition.