Airship AI Holdings, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The following discussion and analysis summarizes the significant factors affecting our operating results, financial condition, liquidity and cash flows as of and for the periods presented below. The following discussion and analysis should be read in conjunction with our financial statements and the 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. ” Overview We are a robust AI-driven data management platform that solves complex data challenges for large institutions operating in dynamic and mission-critical environments with rapidly increasing volumes of data being ingested from a similarly rapidly growing number of data sources. We solve these challenges by structuring “dark” or unstructured data at the edge, the location at which the data is generated and collected, and leveraging purpose-built AI models. Unstructured, or “dark” data, which is typically categorized as qualitative data, cannot be processed and analyzed via conventional data tools and methods. Conversely, structured data, typically categorized as quantitative data, is highly organized and easily decipherable by machine learning algorithms. Structuring and then analyzing data using AI models at the edge, versus transmitting the data from the edge back to a central processing location for structuring and analysis, enables real-time decision making and data-driven operational efficiency. We specialize in ingesting all available metadata from edge-based sensors used by government and law enforcement agencies around the world, including surveillance cameras (video), audio, telemetry, acoustic, seismic, and autonomous devices, along with large commercial corporations with fundamentally similar capabilities and requirements. Data generated by these edge-based sensors, including video, can then be run through our trained AI models to detect objects present within the video frame. Once an object is detected, for example an automobile, additional identifying characteristics of the object can be extracted from the image including the license plate characters and the make, model, and color of the automobile. This process of analyzing, logging and categorizing ingested data is referred to as “structuring” the data. Airship AI’s software allows customers to view structured data both in real-time as well as to conduct searches on the structured data at a later point in time. Real-time structured data use includes, for example, alarms on a specific license plate or a specific make, model or color of automobile. Non-real-time structured data use includes, for example, searching a database of video data that has been previously ingested and stored to find instances of a particular license plate being visible, along with other logged vehicle characteristics such as make, model and color of an automobile. Additional edge deployed AI models enable similar object detection and recognition of common and custom trained objects, such as an aircraft, boat, person, animal, bag, or weapon. Airship AI’s models provide similar data points for these object types allowing analysts the ability to be notified in real-time of the detection of a specified object and similarly search for historically detected objects. Examples include detecting aircrafts and boats along with their respective tail numbers and hull registration numbers. Our AI modelling process starts with pre-trained AI models from our technology ecosystem partners which we then customize using proprietary datasets tailored towards our customers unique workflow requirements. Where customers have pre-existing AI models or engines, we integrate those models or engines into our edge platform allowing customers to leverage proprietary models within the Airship AI software ecosystem. Our primary offerings include Outpost AI, Acropolis, and Airship Command. Our offerings allow customers to manage their data across the full data lifecycle, when and where they need it, using a highly secure permissioned based architecture. Recent Developments On June 27, 2023, BYTS entered into the Merger Agreement with Merger Sub and Airship AI. The Merger Agreement was amended on September 22, 2023. On December 21, 2023, the merger with BYTS closed. Airship AI Holdings, Inc. became the accounting acquiror and the combined entity became the successor SEC registrant under the ticker symbol “AISP”. 24 Table of Contents Fair Value Transactions As a result of the merger, the Company entered into the following transactions that were measured at fair value and vary quarterly with the share price and other items. Any change is non-cash and is recorded as a gain or loss in other income (expense). See Note 14– Fair Value Measurements for more information. Liability as of March 31, 2024 Earnout liability $ 26,618,278 Senior Secured Convertible Promissory Notes 4,204,743 Warrant liability (Public Warrants)- exerciseable at $11.50 per share 7,311,998 Warrant liability (Private Warrants)- exerciseable at $11.50 per share 203,078 Total liabilities measured at fair value $ 38,338,097 Other expense related to instruments recorded at fair value during the three months ended March 31, 2024 $ 30,371,318 Private Placement and Public Warrants At the merger closing, the Company assumed 515,000 private placement warrants and 16,184,612 public warrants. As of March 31, 2024, there were 515,000 private placement warrants and 16,159,112 public warrants outstanding. The warrants are exerciseable at $11.50 per share. See Note 12– Private Placement and Public Warrants for more information. Key Performance Indicators Historically, a majority of our product revenue has consisted primarily of a bundled hardware and software product and to date we have sold or licensed a minimal amount of standalone software. In the future, we expect to see more delivery of our products using a cloud based software solution which will allow us to create additional subscription revenue. We have historically evaluated our business solely based on revenue generated from customers and we have not tracked any other customer-related metrics. As we grow and increase our product offerings and customer base, we intend to modify and develop more advanced performance indicators. We believe the following key performance indicators apply to us in the future: · Growth within existing government customers . While we currently have a strong footprint across multiple large U.S. government agencies, growing our business within these agencies outside of the investigation focused departments is a fundamental area of our projected growth. Our ability to expand our footprint by implementing AI based solutions that leverage our core existing competencies within the agencies will be a critical indicator of the success of this strategy. We will measure progress against this objective through the disclosure of awards for new business within these agencies during the affected timeframe, providing tangible evidence of the success of our strategy to both management and investors alike. · Greater penetration into the commercial marketplace . While we have several existing customers in the commercial marketplace, our ability to build on the solutions we provide those customers and expand that base will be critical to our projected growth objectives. We will measure progress against this objective through the disclosure of the number of new commercial customers added during the affected timeframe, providing tangible evidence of the success of our strategy to both management and investors alike. · Expansion of our edge AI based solutions . We began to sell AI based solutions in late 2022. Our current strategy is highly focused on the transition of data management and analysis workloads to the edge, driving efficiency and cost savings for our customers. This strategy also includes new models being trained to extract data at the edge which enables real-time intelligent decision making for our customers. We will measure progress against this objective through the disclosure of the numbers of edge AI hardware devices we are selling as well as the growth of our edge AI analytic capabilities, providing tangible evidence of the success of our strategy to both management and investors alike. 25 Table of Contents Principal Factors Affecting Our Financial Performance We believe the following factors and trends may cause previously reported financial information not to be necessarily indicative of future operating results or future financial conditions: · Increase in the sales of lower margin solutions as we expand our operational footprint . While our current focus remains on expanding our AI driven software application portfolio, opportunities will continue to present themselves to provide those software-based solutions as part of a larger hardware-based turn-key solutions where Airship AI can provide a unique value-add to the customer. While these solutions will positively affect revenue we anticipate our operating profits in future periods may be adversely affected as compared to previous years due to the lower operating margin for hardware versus software applications. · Challenges due to geo-political driven supply-chain constraints . While many of the COVID-19 driven supply chain issues have been resolved, challenges to the timely production and delivery of Taiwan based products we utilize for our edge AI platform due to geo-political factors is a concern looking forward. In the event that our suppliers are unable to provide timely delivery of those supplies it will significantly impact our ability to meet delivery schedules for existing and anticipated edge AI hardware-based solutions. · Near-term impacts due to merger and acquisition activity . If Airship AI merges with or acquires another company, it is reasonably expected that there will be increased operating expenses and costs associated with the merger that could negatively impact operating profits in the future periods immediately following the M&A event. The extent and longevity of those impacts is not possible to quantify. Segment Reporting The Financial Accounting Standards Board, or FASB, Accounting Standard Codification, or ASC, Topic 280, Segment Reporting , requires that an enterprise report selected information about reportable segments in its financial reports issued to its stockholders. Management monitors the revenue and expense components of the various products and services the Company offers, but operations are managed and financial performance is evaluated on a corporation-wide basis in comparison to a business plan which is developed each year. Accordingly, all operations are considered by management to be one operating segment and one reportable segment as contained in the Consolidated Statements of Operations and Comprehensive Loss to the consolidated financial statements. 26 Table of Contents Results of Operations The following table sets forth key components of our results of operations during the three months ended March 31, 2024 and 2023. (dollars in thousands) Three Months Ended March 31, 2024 2023 $ Variance % Variance Net revenues $ 10,575 $ 2,939 $ 7,636 259.8 % Cost of net revenues 7,947 2,135 (5,812 ) -272.2 % Gross profit 2,628 804 1,824 226.9 % Research and development expenses 695 674 (21 ) -3.1 % Selling, general and administrative expenses 3,335 1,832 (1,503 ) -82.0 % Total operating expenses 4,030 2,506 (1,524 ) -60.8 % Operating loss (1,402 ) (1,702 ) 300 17.6 % Other income (expense): Loss from change in fair value of warrants (6,847 ) - (6,847 ) -100.0 % Loss from change in fair value of earnout liability (21,485 ) - (21,485 ) -100.0 % Loss from change in fair value of convertible debt (2,039 ) - (2,039 ) -100.0 % Loss on note conversion (159 ) - (159 ) -100.0 % Interest expense (32 ) (5 ) (27 ) -540.0 % Other expense - (5 ) 5 100.0 % Total other expense, net (30,562 ) (10 ) (30,552 ) 305520.0 % Loss before income taxes (31,964 ) (1,712 ) (30,252 ) -1767.1 % Income tax benefit (expense) - - - - Net loss $ (31,964 ) $ (1,712 ) $ (30,252 ) -1767.1 % Net Revenues — Revenues for the three months ended March 31, 2024 increased $7,636,000 to $10,575,000 as compared to $2,939,000 for the three months ended March 31, 2023, as a result of increased product sales. We received purchase orders from various federal government agency customers totaling over $13 million from which we shipped and started receiving cash in the first quarter of 2024. Cost of Net Revenues — Cost of net revenues primarily consists of product costs and post customer support. For the three months ended March 31, 2024, cost of sales increased $5,812,000 to $7,947,000 as compared to $2,135,000 for the three months ended March 31, 2023. The increase was due to higher product sales and product mix with high equipment purchases during the three months ended March 31, 2024. Research and Development Expenses — Research and development expenses for the three months ended March 31, 2024 increased $21,000 to $695,000 as compared to $674,000 for the three months ended March 31, 2023. Selling, General and Administrative Expenses — Selling, general and administrative expenses for the three months ended March 31, 2024 increased $1,503,000 to $3,335,000 as compared to $1,832,000 for the three months ended March 31, 2023. The increase was due to (i) increased insurance costs of $291,000; (ii) increased professional fees of $582,000, primarily related to the merger and the Nasdaq listing; and (iii) increased other operating --expenses of $630,000. Other Expense — Other expense for the three months ended March 31, 2024 was $30,562,000 as compared to other expense of $10,000 for the three months ended March 31, 2023. Other expense for the three months ended March 31, 2024 consisted of (i) loss from change in fair value of warrant liability of $6,847,000; (ii) loss from change in fair value of earnout liability of $21,485,000; (iii) loss from change in fair value of convertible debt of $2,039,000; (iv) loss on note conversion of $159,000; and (iv) noncash interest of $32,000. Other expense for the three months ended March 31, 2023 related primarily to interest and other expense of $10,000. Net Loss — Net loss for the three months ended March 31, 2024 was $31,964,000 as compared to net loss of $1,712,000 for the three months ended March 31, 2023. The net loss primarily related to noncash charges of $30,881,000. Noncash charges include (i) depreciation of $2,000; (ii) stock based compensation of $269,000; (iii) net amortization of operating lease right of use asset of $81,000; (iv) loss from change in warrant liability of $6,847,000; (v) loss from change in earnout liability of $21,485,000; (vi) loss from change in fair value of convertible note of $2,039,000; and (vii) loss on note conversions of $159,000. 27 Table of Contents Liquidity and Capital Resources as of March 31, 2024 and December 31, 2023 Liquidity is the ability of a company to generate funds to support its current and future operations, satisfy its obligations, and otherwise operate on an ongoing basis. Significant factors in the management of liquidity are funds generated by operations, levels of accounts receivable and accounts payable and capital expenditures. We formally evaluated our liquidity and cash position most recently in May 2024 when preparing our March 31, 2024 unaudited financial statements. During this process we concluded, based upon existing assets and liabilities, our order backlog and projections, plus the ability to borrow in short term loans from our founder, that we would be able to operate at least for the next twelve months. We have received purchase orders from various federal government agency customers totaling over $13 million from which we shipped and started receiving cash in the first quarter of 2024. As of March 31, 2024, we had cash of approximately $1,726,000. We have incurred losses from operations the past few years and had an accumulated deficit of $49,441,000 as of March 31, 2024. The accumulated deficit includes noncash charges of $30,881,253 and $19,626,884 for the three months ended March 31, 2024 and the year ended December 31, 2023. We also had at March 31, 2024 an adjusted working capital deficit of approximately $2,000,000. The adjusted net working capital deficit excludes current deferred revenue totaling $3,742,000 and convertible debt totaling $4,205,000 (which we expect to be converted to equity). We have primarily funded its operations from operating cash, proceeds from debt borrowings, advances from founders, and proceeds from the merger. Operating Activities Net cash used in operating activities for the three months ended March 31, 2024 was $1,695,000. This amount was primarily related to (i) net loss of $31,964,000; and (ii) net working capital reductions of $611,000; offset by (iii) noncash charges of $30,881,000. Noncash charges include (iv) depreciation of $2,000; (v) stock based compensation of $269,000; (vi) net amortization of operating lease right of use asset of $81,000; (vii) loss from change in warrant liability of $6,847,000; (viii) loss from change in earnout liability of $21,485,000; (ix) loss from change in fair value of convertible note of $2,039,000; (x) loss on note conversions of $159,000. Net cash used in operating activities for the three months ended March 31, 2023 was $990,000. This amount was primarily related to (i) a net loss of $1,712,000; offset by (ii) net working capital increases of $376,000; and (iii) noncash charges of $346,000. Noncash charges include (iii) depreciation of $3,000; (iv) stock based compensation of $137,000; and (v) net amortization of operating lease right of use asset of $206,000. Financing Activities Net cash provided by financing activities for the three months ended March 31, 2024 was $293,000 and consisted proceeds from warrant exercise. Net cash provided by financing activities for the three months ended March 31, 2023 was $865,000 and consisted of founders advances of $950,000 and repayment of small business loan and line of credit of $84,000. Our contractual cash obligations as of March 31, 2024 (excluding debt financing arrangements below) are summarized in the table below: Less Than Contractual Cash Obligations Total 1 Year 1-3 Years 4-5 Years Operating lease cash payments $ 1,382,081 $ 424,158 $ 735,332 $ 222,591 Debt Financing Arrangements On June 22, 2023, we entered into a senior secured convertible promissory note with Platinum Capital Partners Inc. and received $2,000,000. As a condition of funding, we paid off three small notes and accounts payable totaling $374,000. At the option of the holder, the note is convertible into cash, common stock or a combination of cash and stock. We expect the convertible debt to be converted to equity. On November 2 2023, we issued senior secured convertible promissory notes for $600,000 to two private investors. At the option of the holders, the notes are convertible into cash, common stock or a combination of cash and stock. On March 5, 2024, the two private investors converted the debt to equity. Mr. Huang has committed to providing additional temporary funding if it is necessary. 28 Table of Contents We believe that our cash on hand, funding from the completion of the business combination, results of operations and financing transactions will be sufficient to fund our operations for the next twelve months. Equity financing, if obtained, could result in dilution to our then-existing stockholders and/or require such stockholders to waive certain rights and preferences. If such financing is not available on satisfactory terms, or is not available at all, we may be required to delay, scale back, or eliminate the development of business opportunities and our operations and financial condition may be materially adversely affected. Contractual Obligations and Commitments On July 13, 2023, we entered into a lease in Redmond, WA for 15,567 square feet of office and warehouse space which started October 1, 2023. The monthly payment is $25,000 per month. The lease expires October 31, 2027 and the monthly payment increases 3% on July 31, 2024 and each year thereafter. There is a one three year option to extend based on the fair market rate on October 31, 2027. On February 29, 2024, we extended a lease in Moorestown, North Carolina. The Company leases 3,621 square feet and the net monthly payment is $6,488. The lease expires on July 29, 2024. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements (as that term is defined in Item 303 of Regulation S-K) that are reasonably likely to have a current or future material effect on our financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources. Critical Accounting Policies and Estimates Our consolidated financial statements have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Actual results could differ materially from those estimates due to risks and uncertainties, including uncertainty in the current economic environment. To the extent that there are material differences between these estimates and our actual results, our future consolidated financial statements will be affected. We believe that the significant accounting policies described in “ Note 2, Summary of Significant Accounting Policies ” to our audited consolidated financial statements are accurate and complete. The critical accounting estimates and policies during the three months ended March 31, 2024 have not materially changed to those discussed in our Annual Report on Form 10-K for the year ended December 31, 2023. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable to smaller reporting companies.