T3 Defense Inc.: Form 10-Q for the period ended Mar 31, 2025

The following discussion and analysis summarizes the significant factors affecting our financial condition, operating results, liquidity and cash flows as of and for the periods presented below. The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes thereto included elsewhere in this report. The discussion contains forward-looking statements that are based on the beliefs of management, as well as assumptions made by, and information currently available to, management. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and elsewhere in this report, particularly in the sections titled “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”

Unless the context otherwise requires, references in this “Management’s Discussion and Anlalysis of Financial Condition and Results of Operations” to “Nukkleus”, “we”, “us”, “our”, and the “Company” are intended to refer to (i) following the Business Combination (as defined below), the business and operations of Nukkleus, Inc and its consolidated subsidiaries, and (ii) prior to the Business Combination, Old Nukk (the predecessor entity in existence prior to the consummation of the Business Combination) and its consolidated subsidiaries.

Overview

We are a financial technology company that was historically focused on providing software, technology solutions, customer sales and marketing, and risk management technology hardware and software solutions packages for the worldwide retail foreign exchange (“FX”) trading industry and payment services from one fiat currency to another or to digital assets.

In January 2024, we ceased providing our general support services to customers, terminating our existing customer and supplier contracts with a related party, and shifted our focus to our payment services business. In November 2024, we entered into a Settlement Agreement and Release (the “Settlement Agreement”) with a shareholder and one of our subsidiaries to sell the subsidiary that operates the payment services business to the shareholder in consideration of GBP 1,000 (approximately $1,294 at March 31, 2025).

In December 2024, we entered into a Securities Purchase Agreement and Call Option (the “Star Agreement”) with Star 26 Capital Inc. (“Star”), the shareholders of Star (“Star Equity Holders”) and an officer of Nukkleus, acting in his capacity as the representative of the Star Equity Holders, to acquire a controlling 51% interest in Star, an Israeli corporation engaged as a supplier of generators for “iron dome” launchers and other defense products.

As a result of the Settlement Agreement and subject to the closing of the acquisition of Star, our business will be focused on the defense sector.

Recent Developments

In February 2025, our Board of Directors approved a change in our Company’s fiscal year end from September 30 to December 31 effective for the fiscal year beginning January 1, 2024. The change resulted in a transition period from October 1, 2024 to December 31, 2024.

Components of Results of Operations

Operating expenses consist of advertising, professional fees, compensation and related benefits, amortization of intangible assets, other general and administrative, and impairment loss.

Professional fees consists of professional services, such as audit fees, legal service fees, advisory fees, and consulting fees., and software subscriptions for support services.

Compensation and related benefits consists of personnel related expenses incurred in operating our business, including cash compensation and our benefit programs.

Amortization of intangible assets consists of amortization expense recorded on acquired intangible assets with a definite useful life.

Other general and administrative consists of personnel-related expenses incurred to support our business, including executive, customer support, compliance, finance, human resources, legal, and other support operations, and include rent, filing fee, platform fee, travel and entertainment, miscellaneous taxes, and other miscellaneous items.

Other (expense) income, net consists of interest expense, gain (loss) on extinguishment of liabilities, day one loss on issuance of liability-classified stock purchase warrants and embedded derivatives within convertible notes, change in fair value of liability-classified stock purchase warrants and derivative liabilities.

Because these components fluctuate with market conditions, other (expense) income, net can vary widely between periods.

Results of Operations

Comparison For the Three Months Ended March 31, 2025 Versus the Three Months Ended March 31, 2024

Operating Expenses

Professional fees

For the three months ended March 31, 2025, professional fees decreased by approximately $878,000, or 47.9%, as compared to the three months ended March 31, 2024. The significant decrease was primarily attributable to a decrease in advisory service fees of $1,170,000 and legal fees of approximately $222,000, offset by an increase in consulting fees of approximately $388,000 and audit fees of approximately $126,000. This net decrease in professional fees is mainly attributable to the one-time costs incurred in early 2024 in relation to the business combination. We expect that our professional fees will increase in the near future as consultancy agreements were entered into during the fourth quarter with outsourced executives and other personnel of the Company that we anticipate to be in place for the entire fiscal year 2025.

Compensation and related benefits

For the three months ended March 31, 2025, our compensation and related benefits increased by approximately $34,000, or 111.7%, as compared to the three months ended March 31, 2024. We expect that our compensation and related benefits will increase in the near future if the pending acquisition of Star completes during fiscal year 2025.

Other general and administrative expenses

For the three months ended March 31, 2025, total other general and administrative expenses increased by approximately $266,000, or 119.1%, as compared to the three months ended March 31, 2024. The increase was mainly attributable to additional costs associated with operating as a public company, including an increase in D&O insurance of approximately $128,000, marketing fees of approximately $103,000, rent expenses of approximately $73,000 attributable to new offices established in Israel and New York, entertainment and travel of approximately $29,000 attributable to the travel by our CEO and other business expenses of approximately $60,000, offset by a decrease in filing fees of approximately $127,000. We expect that other general and administrative expenses will increase in the near future if the pending acquisition of Star completes during fiscal year 2025.

Other Income (Expense)

For the three months ended March 31, 2025, other income (expense), net, increased approximately $104,658,000, or 1,043,970.3%, as compared to the three months ended March 31, 2024. The increase was attributable to, an increase in gain from change in fair value – stock purchase warrant liabilities of approximately $104,278,000 andgain from change in fair value – convertible note embedded derivative of approximately $567,000, offset by an increase in interest expense due to amortization of debt discounts of approximately $165,000 and an increase in interest expense on debt-related parties of approximately $24,000.

Discontinued Operations

Net loss from discontinued operations was $182,755 for the three months ended March 31, 2025 compared to $334,216 for the three months ended March 31, 2024. The decrease was due to a decrease in net loss from the operations of the Company’s wholly owed subsidiary DRFQ.

Liquidity and Capital Resources

We generated a pre-tax net income from continuing operations of $103,140,894 for the three months ended March 31, 2025 and incurred a pre-tax net loss of $2,095,201 for the three months ended March 31, 2024, and have an accumulated deficit of $98,117,604 as of March 31, 2025 and $201,075,743 at December 31, 2024. As of March 31, 2025, we had a working capital deficit of $56,246,392, including $4,462,916 of cash.

We have not been able to generate sufficient cash from operating activities to fund our ongoing operations. Since our inception, we have raised capital through private sales of common stock and debt securities. Our future success is dependent upon our ability to achieve profitable operations and generate cash from operating activities. There is no guarantee that we will be able to generate enough revenue and/or raise capital to support our operations.

To the extent that current and anticipated future sources of liquidity are insufficient to fund our future business activities and cash and other requirements, we may be required to seek additional equity or debt financing. The sale of additional equity would result in additional dilution to our stockholders. The incurrence of additional debt financing would result in debt service obligations and the instruments governing such debt could provide for operating and financing covenants that would restrict our operations. Even if debt financing is available, the cost of additional financing may be significantly higher than our current debt.

The risks and uncertainties surrounding the Company’s ability to continue to raise capital and its limited capital resources raise substantial doubt as to the Company’s ability to continue as a going concern for twelve months from the issuance of these consolidated financial statements. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which contemplate our continuation as a going concern.

Cash Flows

The following summarizes the key components of our cash flows for the three months ended March 31, 2025 and 2024:

Operating activities

Net cash flow used in operating activities for the three months ended March 31, 2025 was approximately $1,342,000, which primarily reflected our consolidated net income of approximately $102,958,000, adjusted for changes in working capital accounts and certain non-cash income (expenses) of approximately $104,532,000 (including the change in fair value of our liability-classified stock purchase warrants and derivative liabilities of approximately $104,846,000, offset by amortization of debt discount of approximately $135,000, stock-based compensation of approximately $178,000, and depreciation expense of approximately $300).

Net cash flow used in operating activities for the three months ended March 31, 2024 was $1,123,000, which primarily reflected our consolidated net loss of approximately $2,429,000, adjusted for changes in working capital accounts and certain non-cash expense of approximately $75,000 (including stock-based compensation of approximately $75,000).

Investing activities

Net cash flow used in investing activities was approximately $810,221 for the three months ended March 31, 2025, which consisted of an additional advance payment to Star of $800,000 in connection with the plan acquisition of Star, and a purchase of computer equipment of $10,221.

There were no cash flows provided by investing activities for the three months ended March 31, 2024.

Financing activities

There were no cash flows provided by financing activities for the three months ended March 31, 2025.

Net cash flow provided by financing activities was $293,000 for the three months ended March 31, 2024, which consisted of proceeds from loan payable – related parties of $293,000.

Off-Balance Sheet Arrangements

We had no outstanding derivative financial instruments, off-balance sheet guarantees, interest rate swap transactions or foreign currency contracts. We do not engage in trading activities involving non-exchange traded contracts.

Critical Accounting Estimates

Our consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q are prepared in accordance with GAAP. The preparation of consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs, and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from our estimates. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, operating results, and cash flows will be affected.

See Note 3. Summary of Significant Accounting Policies of the Notes to our consolidated financial statements included in Part II, Item 8 of this Quarterly Report on Form 10-Q for a summary of significant accounting policies and significant estimates and assumptions and their effects on our financial statements. Below are the significant estimates and assumptions that we consider critical because they involve a significant amount of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations.

Stock-based Compensation

We account for share-based payments that involve the issuance of shares of our common stock to employees and nonemployees and meet the criteria for share-based awards as stock-based compensation expense based on the grant-date fair value of the award. The Company has elected to recognize the adjustment to stock-based compensation expense in the period in which forfeitures occur. We recognize compensation expense for awards with only service conditions on a straight-line basis over the requisite service period for the entire award.

If factors change, and we utilize different assumptions including the probability of achieving performance conditions, share-based compensation cost on future award grants may differ significantly from share-based compensation cost recognized on past award grants. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate any remaining unearned share-based compensation cost or incur incremental cost. Share-based compensation cost affects our compensation and benefits expenses.

Warrants

Classification: The Company determines the accounting classification of warrants it issues as either liability or equity classified by first assessing whether the warrants meet liability classification in accordance with ASC 480-10, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (“ASC 480”), then in accordance with ASC 815-40 (“ASC 815”), Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock. Under ASC 480, warrants are considered liability classified if the warrants are mandatorily redeemable, obligate the Company to settle the warrants or the underlying shares by paying cash or other assets, or warrants that must or may require settlement by issuing variable number of shares. If warrants do not meet liability classification under ASC 480, the Company assesses the requirements under ASC 815, which states that contracts that require or may require the issuer to settle the contract for cash are liabilities recorded at fair value, irrespective of the likelihood of the transaction occurring that triggers the net cash settlement feature. If the warrants do not require liability classification under ASC 815, and in order to conclude equity classification, the Company also assesses whether the warrants are indexed to its Common Stock and whether the warrants are classified as equity under ASC 815 or other applicable GAAP. After all relevant assessments, the Company concludes whether the warrants are classified as liability or equity. Liability classified warrants require fair value accounting at issuance and subsequent to initial issuance with all changes in fair value after the issuance date recorded in the statements of operations. Equity classified warrants only require fair value accounting at issuance with no changes recognized subsequent to the issuance date.

We assess the classification of our stock purchase warrants at each reporting date to determine whether a change in classification between equity and liability is required. For modified stock purchase warrants that result in a change of classification from equity to liability, a liability is recognized equal to the fair value on the date of modification, additional paid-in capital is adjusted by the fair value of the warrant on the date of issuance, and the difference is recognized as a non-cash gain or loss on the consolidated statements of operations and comprehensive loss.

Valuation: The fair value of our equity-classified stock purchase warrants and liability-classified stock purchase warrants are determined utilizing Level 3 inputs using a Black-Scholes-Merton option valuation model and a Monte Carlo simulation model, respectively.

In both models, the fair value of an award is affected by our stock price on the date of measurement as well as other assumptions, including the estimated volatility of our stock price over the term of the stock purchase warrant as of the measurement date and the estimated period of time that we expect third parties to hold the stock purchase warrants at the measurement date. The risk-free interest rate assumption we use is based upon United States Treasury interest rates appropriate for the expected life of the stock purchase warrant.

As our stock has limited trading history on NASDAQ, we use the historical volatility of our peer companies in order to estimate future stock price trends. We expect third parties to hold their stock purchase warrants for the contractual term as we do not have any history to support a shorter term and do not anticipate stock purchase warrants to be exercised prior to the end of the term. Our expected dividend rate is zero since we do not currently pay cash dividends on our common stock and do not anticipate doing so in the foreseeable future.

We use the Monte Carlo simulation model for our liability-classified stock purchase warrants in order to incorporate other subjective assumptions based on the terms of the specific stock purchase warrant agreements or the related host contract. For our liability-classified stock purchase warrants as of March 31, 2025, we included the probability of a fundamental event, as defined in the relevant agreements, occurring in our assumptions.

The aforementioned inputs entered into the models we use to fair value our stock purchase warrants are subjective estimates and changes to these estimates will cause the fair value of our stock purchase warrants and related debt issuance discount we recognize to vary.

Derivative Financial Instruments

Classification: We evaluate our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives in accordance with ASC 815. Derivative instruments are initially recorded at fair value on the grant date and re-valued at each reporting date, with changes in the fair value reported in the consolidated statements of operations and comprehensive loss included in this Report under “Item 8. Financial Statements”. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is re-assessed at the end of each reporting period. Derivative liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement or conversion of the instrument could be required within 12 months of the balance sheet date. Bifurcated embedded derivatives are classified with the related host contract on the Company’s balance sheet.

Valuation: We use the Monte Carlo simulation model for our bifurcated embedded derivatives in order to incorporate subjective assumptions based on the terms of the specific host contracts. For our bifurcated embedded derivatives issued in connection with our December 2024 convertible note payable, we included the probability of a fundamental event, as defined in the relevant agreements, occurring in our assumptions in addition to the estimated volatility of our stock price over the term of the bifurcated embedded derivative as of the measurement date, the remaining term of the host contract at the measurement date, the risk-free interest rate based upon United States Treasury interest rates appropriate for the expected term, the conversion discount, and the redemption premium.

Legal and other contingencies

We are subject to various legal proceedings and claims that arise in the ordinary course of business, the outcomes of which are inherently uncertain, and such uncertainty may be enhanced due to the industry in which we operate. We record a liability when it is probable that a loss has been incurred and the amount is reasonably estimable, the determination of which requires significant judgment. In addition, we record recoveries of these losses when it is probable that they will be collected. These estimates are highly sensitive to change and involve variables that are not completely within our control nor practicable to model, including decisions made by regulators and settlement negotiations. Resolution of legal and other contingencies in a manner inconsistent with management’s expectations could have a material impact on our financial condition and results of operations.

Recently Issued Accounting Pronouncements

For information about recently issued accounting standards, refer to Note 3 to our Consolidated Financial Statements appearing elsewhere in this report.

Foreign Currency Risk

Foreign currency transaction risk

Revenues, expenses, and financial results of our foreign subsidiaries are recorded in the functional currency of these subsidiaries. Our foreign currency exposure is primarily related to transactions denominated in British Pounds attributable to cash, customer custodial funds and customer custodial cash liabilities and intercompany transactions where the transaction currency is different from a subsidiary’s functional currency. Changes in foreign exchange rates, and in particular a weakening of foreign currencies relative to the U.S. dollar may negatively affect our results of operations as expressed in U.S. dollars. We have experienced and will continue to experience fluctuations in our results of operations as a result of gains or losses on the settlement and the remeasurement of monetary assets and liabilities denominated in foreign currencies that are not the functional currency of the respective entity.

If an adverse 10% foreign currency exchange rate change was applied to the largest foreign currency exposure (e.g. British Pound) or to all foreign currency exposures in aggregate, of monetary assets, liabilities, and commitments denominated in currencies other than its functional currency as of March 31, 2025 and December 31, 2024, it would not have a material impact on our financial results.

From time to time, we may enter into derivatives or other financial instruments in an attempt to hedge our exposure to foreign currency exchange risk. It is difficult to predict the impact hedging activities would have on our results of operations. Additionally, the volatility of exchange rates depends on many factors that we cannot forecast with reliable accuracy. Our international operations increase our exposure to exchange rate fluctuations and, as a result, such fluctuations could have a material impact on our future results of operations and cash flows.

Foreign currency translation risk

Fluctuations in functional currencies from our net investment in international subsidiaries expose us to foreign currency translation risk, where changes in foreign currency exchange rates may adversely affect our results of operations upon translation into U.S. dollars. See the consolidated statements of comprehensive income (loss) in Part II, Item 8 of this Quarterly Report on Form 10-Q for translation adjustments for the three months ended March 31, 2025 and 2024, a 10% increase or decrease in foreign currency exchange rates used in translating the financial statements of subsidiaries with functional currencies other than our reporting currency would not have a material impact on our financial results.

We are a smaller reporting company as defined in Rule 12b-2 of the Exchange Act and are not required to provide the information required under this item.

Evaluation of Disclosure Controls

Our chief executive officer who also serves as our principal financial officer evaluated the effectiveness of our “disclosure controls and procedures” as of March 31, 2025, the end of the period covered by this Quarterly Report on Form 10-Q. The term “disclosure controls and procedures” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files under the Exchange Act is accumulated and communicated to a company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Based on the evaluation of our disclosure controls and procedures as of March 31, 2025, our Chief Executive Officer who also serves as our principal financial officer concluded that, as of such date, our disclosure controls and procedures were effective.

Material Weaknesses in Internal Control Over Financial Reporting

A material weakness is defined as a deficiency or combination of deficiencies in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of annual or interim financial statements will not be prevented or detected on a timely basis.

Management identified material weaknesses in the Company’s internal control over financial reporting as of December 31, 2024 related to the Company possessing sufficient resources to properly identify and account for the evaluation of intangible assets and its cost-method investments and to implement and sustain appropriate entity-level controls.

Following the identification and communication of the material weakness described above, management commenced remediation actions relating to this material weakness beginning in the fourth quarter of fiscal year 2024, as follows:

• We are utilizing the services of external consultants for non-routine and\or technical accounting issues as they arise.
• We are expanding and improving our review process for complex accounting transactions. We plan to further improve this process by enhancing access to accounting literature, identification of third-party professionals with whom to consult regarding complex accounting applications and consideration of additional staff with the requisite experience and training to supplement existing accounting professionals.
• We are implementing enhancements and process improvements, including the design and implementation of well-defined controls and related control attributes

The material weaknesses identified above will not be considered fully remediated until these additional controls and procedures have operated effectively for a sufficient period of time and management has concluded, through testing, that these controls are effective. Our management will monitor the effectiveness of our remediation plans and will make changes management determines to be appropriate. If not remediated, these material weaknesses could result in material misstatements to our annual or interim consolidated financial statements that may not be prevented or detected on a timely basis or result in a delayed filing of required periodic reports. If we are unable to assert that our internal control over financial reporting is effective, investors may lose confidence in the accuracy and completeness of our financial reports, the market price of our common stock could be adversely affected, and we could become subject to litigation or investigations by Nasdaq, the SEC, or other regulatory authorities, which could require additional financial and management resources.

As of March 31, 2025, management has performed adequate testing to conclude that the material weakness identified in the prior fiscal year has not been remediated as of March 31, 2025 related to the Company possessing sufficient resources to properly identify and account for the evaluation of intangible assets and its cost-method investments and to implement and sustain appropriate entity-level controls.

Changes in Internal Control Over Financial Reporting

Except as set forth above, there were no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2025 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedure, management recognizes that any controls and procedures, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedure relative to their costs.

Risk factors that affect our business and financial results are discussed in Part I, Item 1A “Risk Factors,” in our Annual Report on Form 10-KT for the period ended December 31, 2024 as filed with the SEC on May 8, 2025 (“Annual Report”). There have been no material changes in our risk factors from those previously disclosed in our Annual Report. You should carefully consider the risks described in our Annual Report which could materially affect our business, financial condition or future results. The risks described in our Annual Report are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results. If any of the risks actually occur, our business, financial condition, and/or results of operations could be negatively affected.