What changed in this filing

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Item 7. Management’s Discussion and Analysis

2024-03-21 compared with 2023-03-17 · 69 added, 72 removed, 196 unchanged (42% of the section changed)

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We are a technology company focused on leveraging the power of information technology to help solve our nation’s most pressing national security challenges.

We provide USG and commercial clients with Cybersecurity, Software Development, Systems Engineering, Information / Electronic Warfare, Program Support, and Data Analytics services.

We also offer subject matter expertise in artificial intelligence / machine learning, 5G technologies, model-based systems engineering, program management, information assurance, intelligence analysis, and CMMC compliance.

In addition to constantly innovating and enhancing our organic capabilities, Castellum is executing strategic acquisitions of firms that share our passionate commitment to U.S.

We provide clients in the United States government (“USG”), financial services, healthcare, and other users of large data applications with services which include intelligence analysis, software development, software engineering, program management, strategic and mission planning, information assurance, cybersecurity and policy support, data analytics, and MBSE.

In addition to constantly innovating and enhancing our organic capabilities, Castellum is executing strategic acquisitions of technology companies in the areas of cybersecurity, information technology (“IT”), electronic warfare, information warfare, and information operations with businesses in the defense, federal, civilian, and commercial markets that share our passionate commitment to U.S.

national security and have a history of bringing exceptional value to their clients.

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Securities and Exchange Commission on October 12, 2022.

On December 1, 2023, the Company filed a universal shelf registration statement on Form S-3 (File No.

333-275840) which was declared effective by the U.S.

Securities and Exchange Commission on December 12, 2023.

Key Components of Our Results of Operations

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• General and administrative expenses consist primarily of corporate and administrative labor expenses, administrative bonuses, legal expenses, IT expenses, and insurance expenses.

Realized Gain on Investment

Realized gain on investment related to a sale of an investment in a private company held by MFSI.

Interest Expense, Net of Interest Income

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Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

The effect on deferred tax assets and liabilities of a change in

tax rates is recognized in income in the period that includes the enactment date.

The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Differences between statutory tax rates and effective tax rates relate to permanent tax differences.

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General and administrative expenses 17,697,886 13,586,600 4,111,286 30.3 %

Loss from change in fair value of contingent earnout 555,000 — 555,000 100.0 %

Goodwill impairment loss 6,919,094 — 6,919,094 100.0 %

(Gain) Loss from change in fair value of contingent earnout (92,000) 555,000 (647,000) (116.6) %

Total operating expenses 35,344,152 27,561,253 7,782,899 28.2 %

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Total revenues increased by $3,053,169 or 7.2% to $45,243,812 for the year ended December 31, 2023 from $42,190,643 for the year ended December 31, 2022.

This increase was driven largely by the contributions from the acquisitions of SSI and Merrison during the third quarter of 2021 as well as the contributions from LSG acquired during the second quarter of 2022.

This increase in revenue was due to the acquisition of GTMR (“GTMR Acquisition”), partially offset by lost positions on ongoing contracts principally at SSI and Corvus reducing revenue.

Cost of revenues

Total cost of revenues increased by $1,975,159 or 8.0% to $26,568,485 for the year ended December 31, 2023 from $24,593,326 for the year ended December 31, 2022.

This increase was driven primarily by the increased level of effort on contracts proportionate to the growth of revenues due to the acquisition activity noted above.

This increase was driven primarily by the net increased level of effort on contracts proportionate to the changes in revenue noted above.

Total gross profit increased by $1,078,010 or 6.1% to $18,675,327 for the year ended December 31, 2023 from $17,597,317 for the year ended December 31, 2022.

This increase was driven primarily by the growth in revenues due to contributions from SSI, Merrison and LSG, offset by costs of revenues as noted above.

This increase was driven by changes in revenue noted above.

Operating expenses

Total operating expenses increased by $7,782,899 or 28.2% to $35,344,152 for the year ended December 31, 2023 from $27,561,253 for the year ended December 31, 2022.

This fluctuation was primarily driven by an increase of $8,449,752 in indirect costs during the year ended December 31, 2022, largely attributable to the increase in benefits expense related to the Company’s growth in headcount year over year.

In addition, this increase was also driven by increases in non-cash stock based compensation related to executive bonuses.

This increase was offset by a decrease in general and administrative expenses of $952,453, or 6.6%, which was primarily due to a decrease in acquisition fees from the prior year as well as less acquisition-based stock based compensation in 2022 paid to executives due to less acquisition activity in 2022.

The increase of $709,253 in overhead was primarily driven by an increase in overhead salaries related to our growth in headcount compared to 2021.

The decrease in indirect cost of $(2,924,288) was driven primarily by a reduction in acquisition based bonuses to certain executives from 2022, as well as cost savings implemented in 2023.

The increase in overhead costs of $323,807 is related to increases in lease expense due to the GTMR Acquisition.

The increase in general and administrative costs of $4,111,286 consist of increases in non cash stock based compensation granted to certain employees, as well as increases in general and administrative salary expense as we in-sourced certain functions such as accounting and business development.

The recognition of goodwill impairment resulted from a loss recorded during the

third quarter of 2023.

The decrease in the loss from change in fair value of contingent earnout is due to adjustments as we finalized the amount after the earnout period ended in late 2023.

Other income (expense)

Other income (expense) increased by $(1,646,582) or 66.5% to $(4,124,506) for the year ended December 31, 2022 from $(2,477,924) for the year ended December 31, 2021.

This increase was primarily driven by the increase in the amount of debt outstanding during 2022 as well as rate increases during 2022 on its variable rate debt under its agreement with Live Oak Bank.

Income tax (expense) benefit

Income tax (expense) benefit increased by $(3,476,239) or (130.9)% to $(819,596) for the year ended December 31, 2022 from $2,656,643 for the year ended December 31, 2021.

This increase was primarily driven by the increase in deferred tax expense as well as overall revenue growth from the prior year through inorganic contributions from SSI, Merrison and LSG.

Other income (expense) decreased by $1,736,036 or (42.1)% to $(2,388,470) for the year ended December 31, 2023 from $(4,124,506) for the year ended December 31, 2022.

This decrease was primarily driven by decreases in the fair value of the derivative liability offset by an increase in interest expense due to rate increases during 2023 on our variable rate debt under our agreement with Live Oak Bank.

Income tax benefit (expense)

Income tax benefit (expense) increased by $2,076,713 or (253.4)% to $1,257,117 for the year ended December 31, 2023 from $(819,596) for the year ended December 31, 2022.

This increase was primarily driven by the increase in deferred tax liabilities from the acquisition of GTMR and subsequent release of valuation allowance.

Year Ended December 31, 2022 Compared to Year Ended December 31, 2021

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Net loss to common shareholders $ (15,008,554) $ (7,558,720) $ (7,449,834) 98.6 %

Revenues were $25,067,450 for 2021 as compared to $13,338,667 for 2020.

This $11,728,783 increase was primarily driven by the contribution from acquisitions completed in Q3 and Q4 2021.

Incremental contributions from those acquisitions were $10,938,015, which was complemented by a $790,7668 increase in organic sales, which were $14,129,435 in 2021.

Total revenues increased by $17,123,193 or 68.3% to $42,190,643 for the year ended December 31, 2022 from $25,067,450 for the year ended December 31, 2021.

Cost of revenues

Cost of revenues was $13,992,898 for 2021 as compared to $7,161,627 for 2020.

This $6,831,271 increase was primarily driven by the revenue increases contributed by the acquisitions noted above, accounting for $6,250,769 of the total increase.

As a percentage of revenue, cost of revenue was 55.8% for 2021 (54.8% for organic and 57.1% for acquisition activity), an increase of 2.1% from 53.7% for 2020, which was driven primarily by a higher-cost contract mix resident at Merrison and SSI.

Gross profit was $11,074,552 for 2021 as compared to $6,177,040 for 2020.

This $4,897,512 increase was primarily driven by acquisitions, contributing $4,687,246 in total, which was complemented by a $210,266 increase in organic gross profit, for a total of $6,387,306.

Gross profit margin was 44.2% for 2021 (45.2% for organic and 42.9% for acquisition activity), a decrease of 2.1% from 46.3% for 2020, which was driven primarily by the higher cost contract mix present at Merrison and SSI.

Total cost of revenues increased by $10,600,428 or 75.8% to $24,593,326 for the year ended December 31, 2022 from $13,992,898 for the year ended December 31, 2021.

This increase was driven primarily by the increased level of effort on contracts proportionate to the growth of revenues due to the acquisition activity noted above.

Total gross profit increased by $6,522,765 or 58.9% to $17,597,317 for the year ended December 31, 2022 from $11,074,552 for the year ended December 31, 2021.

This increase was driven primarily by the growth in revenues due to contributions from SSI, Merrison and LSG, offset by costs of revenues as noted above.

Operating expenses

Indirect costs were $3,409,649 for 2021 as compared to $1,679,783 for 2020.

This $1,729,866 increase resulted from a $2,068,091 increase from acquisition activity, which was slightly offset by a $338,225 decrease in organic activity, which

totaled $1,341,558 for 2021.

This decrease in indirect costs for legacy is primarily due to a $537,998 decrease in costs related to policy changes to vacation, holiday, and sick leave, offset by an increase of $199,773 in other fringe benefits costs consisting primarily of health insurance costs driven by an increase in headcount.

Overhead was $850,999 for 2021 as compared to $276,855 for 2020.

This $574,144 increase was primarily due to an increase of $420,324 resulting from activity related to acquisitions, with legacy activities contributing a $127,113 thousand increase in recruiting expenses related to scope of work changes related to existing contracts.

General and administrative expenses were $14,539,054 for 2021 as compared to $5,688,551 for 2020.

$2,324,663 of this increase was due to activity related to acquisitions, while $4,448,632 related to executive compensation increases (with newly hired executives’ base pay and other executive bonuses), and $1,886,167 related to stock-based compensation (arising primarily from time-based vesting for newly hired executives and for performance-based compensation for other executives).

Total operating expenses increased by $8,761,552 or 46.6% to $27,561,253 for the year ended December 31, 2022 from $18,799,701 for the year ended December 31, 2021.

In addition, this increase was also driven by increases in non-cash stock based compensation related to executive bonuses.

The increase of $709,253 in overhead was primarily driven by an increase in overhead salaries related to our growth in headcount compared to 2021.

Other income (expense)

Realized gain on investment was $38,851 for 2021 as compared to $0 for 2020.

This $38,851 increase was due to a gain from an investment in a private company sold by MFSI in 2021.

Interest expense, net of interest income was $2,516,775 for 2021 as compared to $2,295,906 for 2020.

This $220,869 increase relates to $106,149 of interest expense relating to an acquisition, the majority of which related to interest on the Live Oak Term Banking Company note secured to acquire SSI.

$112,025 of the increase related to amortization of discounts for legacy debt.

Other income (expense) increased by $(1,646,582) or 66.5% to $(4,124,506) for the year ended December 31, 2022 from $(2,477,924) for the year ended December 31, 2021.

Income tax (expense) benefit

Benefit from income taxes was $2,656,643 for 2021 as compared to $1,056,562 for 2020.

This $1,600,081 increase was the result of the overall increase in operating expenses relative to revenues, (the largest driver being certain general and administrative expenses (“G&A”) expense referenced above), with an immaterial impact from changes in the effective tax rate.

Income tax (expense) benefit increased by $(3,476,239) or (130.9)% to $(819,596) for the year ended December 31, 2022 from $2,656,643 for the year ended December 31, 2021.

This increase was primarily due to the Company establishing a full valuation allowance against its deferred tax assets.

Contract Backlog

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• Priced Options .

Priced contract options represent 100% of the revenue value of all future contract option periods under existing contracts that may be exercised at our clients’ option and for which funding has not been appropriated or otherwise authorized.

Priced contract options represent 100% of the potential revenue value of all scheduled and unscheduled future contract option periods or orders under existing contracts that may be exercised at our clients’ option and for which funding has not been appropriated or otherwise authorized.

Our backlog does not include contracts that have been awarded but are currently under protest and also does not include any task orders under IDIQ contracts, except to the extent that task orders have been awarded to us under those contracts.

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Total Backlog $ 108,014,640

Our total backlog consists of remaining performance obligations, certain orders under contracts for which the original period of performance has expired, and unexercised option periods and other unexercised optional orders.

As of December 31, 2022, the Company had $81,345,476 of remaining performance obligations.

We expect to recognize

approximately 52% of the remaining performance obligations over the next 12 months, and approximately 75% over the next 24 months.

Our total backlog consists of remaining performance obligations, certain orders under contracts for which the original period of performance has expired, unexercised option periods and other unexercised or unscheduled optional orders.

Excluding unscheduled options orders, as of December 31, 2023, the Company had $108,014,640 of funded, unfunded and scheduled priced options.

We expect to recognize approximately 34% of the remaining performance obligations over the next 12 months, and approximately 57% over the next 24 months.

Including priced options that have been awarded but not yet scheduled of $46,431,225, our grand total backlog is $154,445,865.

The remainder is expected to be recognized thereafter.

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Liquidity and Capital Resources

We have historically sourced our liquidity requirements with cash flows from operations, borrowings under our current credit facilities, and in October 2022, with an equity issuance through the listing of our common stock on the NYSE American LLC.

As of December 31, 2023, we had $1,830,841 of cash and cash equivalents on hand and unused borrowing capacity of $324,975 from our revolving line of credit.

We believe our existing cash and cash equivalents provided by our ongoing operations together with funds available under our credit facilities will be sufficient to meet our working capital, capital expenditures and cash needs for the next 12 months and beyond.

In January and February of 2024, we undertook the following significant equity and debt transactions that enhance our liquidity and sources of funds:

• In January 2024, after filing a universal shelf registration statement on Form S-3 with the SEC in December of 2023 allowing us to issue additional equity (“Security Offering”), we raised net proceeds of approximately $2,200,000.

• In February 2024, we used the proceeds from the Security Offering to pay the outstanding principal and accrued interest owed on a Note Payable to Crom in the amount of $847,000.

• In February 2024, we agreed with Emil Kaunitz to extend the maturity date of a $400,000 note payable from December 31, 2024, to August 1, 2025, after which we will make monthly principal payments of $50,000 per month for eight months.

• In February 2024, we entered into a new $4,000,000 revolving credit facility with Live Oak Banking Company which matures on February 22, 2025 (the “New Live Oak Revolver”).

The New Live Oak Revolver replaces the $950,000 revolving credit facility noted above (“Old Live Oak Revolver”), and we rolled over the $625,025 outstanding principal balance outstanding on the Old Live Oak Revolver.

We also made payments of $1,209,617

to the holders of two notes payable noted below.

We have unused borrowing capacity of approximately $2,165,383 under the New Live Oak Revolver.

• In February 2024, we agreed with Robert Eisiminger to extend the maturity dates of two notes payable totaling $6,000,000 from September 30, 2024, to August 31, 2026.

We also accessed the New Live Oak Revolver to pay off a third note totaling $400,000.

• In February 2024, we agreed with the Buckhout Charitable Remainder Trust to pay down and amend a convertible promissory note payable totaling $3,209,617.

We accessed the New Live Oak Revolver to pay down principal of $809,617.

We simultaneously agreed to enter into a new note payable in the principal amount of $2,400,000 which matures on August 31, 2026, and may not be converted into common stock.

Commencing in September 2024, we will monthly principal payments of $100,000 for 24 months.

For more information related to these transactions, refer to Note 16 under Part II, Item 8, of this Annual Report on Form 10-K.

We believe our existing cash and cash equivalents provided by our ongoing operations, together with funds available through the transactions noted above, will be sufficient to meet our working capital, capital expenditures, and cash needs for the next 12 months and beyond.

Our material cash requirements from known contractual and other obligations primarily relate to payments on our credit facilities.

For information related to these cash requirements, refer to Note 6, Note 7, Note 8 and Note 9 under Part II, Item 8, of this Annual Report on Form 10-K.

For information related to these cash requirements, refer to Note 6 , Note 7 , Note 8 , Note 9 , and Note 16 under Part II, Item 8, of this Annual Report on Form 10-K.

Information about our cash flows is presented in our statements of cash flows and is summarized in the following table:

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2023 2022 2021

Net cash provided by (used in):

Net cash (used in) provided by:

Operating activities

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Operating activities

Net cash provided by operating activities increased to $990,163, for the year ended December 31, 2022, from $(1,350,136) for the year ended December 31, 2021.

This increase in net cash provided by operating activities was primarily driven by an increase in revenues, decreases in accounts receivables (due to timing of collections), as well as noncash adjustments related to stock based compensation, depreciation and amortization, and a change in accounts receivable during the year ended December 31, 2022.

Investing activities

Net cash provided by (used in) investing activities decreased to $(339,282), for the year ended December 31, 2022, from $808,834, for the year ended December 31, 2021.

The decrease in net cash provided by (used in) investing activities was primarily due to the cash paid in the acquisition of LSG during 2022 and the cash received from the acquisitions of MFSI, Merrison, and SSI as well as the sale of an investment in a private company held by MFSI in 2021.

Financing activities

Net cash provided by financing activities increased to $1,972,100, for the year ended December 31, 2022, from $146,835, for the year ended December 31, 2021.

The increase in net cash provided (used) by financing activities was primarily due to the proceeds from uplisting to the NYSE American, proceeds from notes payable obtained in 2022, and issuance of preferred and common stock.

This increase was partially offset by repayments of notes payable and a repayment of amounts to due to seller.

Comparison of the Years Ended December 31, 2021 and 2020

Operating activities

Net cash used in operations in 2021 increased to $(1,350,136) compared to net cash flow provided by operations in 2020 of $1,006,091, a difference of $(2,356,227).

This decrease in operating cash flows period over period is driven by an increase in net loss of $(4,838,937), decreases in accounts receivables (primarily due to the timing of collections) and contract assets of $(2,295,437), a $(1,664,647) decrease in deferred tax provision (our deferred tax benefit increased), offset by $5,982,475 increase in non-cash stock-based compensation expense.

We used $(2,264,447) in operating activities for the year ended December 31, 2023, compared to $990,163 provided by operating activities for the year ended December 31, 2022.

This decrease in net cash from operating activities was primarily driven by an increase in net loss, increases in accounts receivables (due to timing of collections), as well as noncash adjustments related to changes in the fair value of derivative liabilities and contingent earnout during the year ended December 31, 2023.

Investing activities

Net cash provided by investing activities for 2021 was $808,834 compared to net cash flow used in investing activities for 2020 of $(5,450), a difference of $814,284.

This increase in investing cash flows primarily resulted from $453,480 received in 2021 resulting from acquisitions of MFSI, Merrison, and SSI (net of amounts paid), as well as $365,572 received from the sale of two investments in private companies held by MFSI.

Net cash used in investing activities increased to $(440,985), for the year ended December 31, 2023, from $(339,282), for the year ended December 31, 2022.

The increase in net cash used in investing activities was primarily due to the cash paid in the acquisition of GTMR during 2023.

Financing activities

Net cash flow provided by financing activities was $146,835 in 2021 compared to net cash flow of $109,000 provided by financing activities in 2020, a difference of $37,835.

This increase in financing cash flows was primarily a result of 2021 activities, including a $525,000 increase in proceeds from issuance of preferred and common stock over 2020 related to acquisition funding and capital raised from accredited investors, offset by decreases of $(470,626) due to repayments of notes payable related to the acquisitions of SSI and Corvus.

During the year ended December 31, 2023, we used $(104,623) in financing activities, primarily due to reduction in proceeds from issuance of preferred and common stock, the reduction in proceeds from notes payable, and an increase in payments on notes payable, compared to net cash provided by financing activities of $1,972,100, for the year ended December 31, 2022.

Critical Accounting Policies and Estimates

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(3) determine the transaction price;

(4) allocate the transaction price to the

performance obligations in the contract;

(4) allocate the transaction price to the performance obligations in the contract;

and (5) recognize revenue when (or as) the entity satisfies a performance obligation.

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Due to the many variables inherent in the estimation of a business’s fair value and the relative size of our goodwill, if different assumptions and estimates were used, it could have an adverse effect on our impairment analysis.

During the third quarter of 2023, due to decline in stock price, Management determined that a triggering event occurred representing an indicator of goodwill impairment, resulting in a non-cash charge of $6,919,094.

Income Taxes and Uncertain Tax Positions

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis