Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Overview
Air T, Inc. (the “Company,” “Air T,” “we” or “us” or “our”) is a holding company with a portfolio of operating businesses and financial assets. Our goal is to prudently and strategically diversify Air T’s earnings power and compound the growth in its free cash flow per share over time.
We currently operate in four industry segments:
• Overnight air cargo, which operates in the air express delivery services industry;
• Ground equipment sales, which manufactures and provides mobile deicers and other specialized equipment products to passenger and cargo airlines, airports, the military and industrial customers;
• Commercial aircraft, engines and parts, which manages and leases aviation assets; supplies surplus and aftermarket commercial jet engine components; provides commercial aircraft disassembly/part-out services; commercial aircraft parts sales; procurement services and overhaul and repair services to airlines and;
• Corporate and other, which acts as the capital allocator and resource for other consolidated businesses. Further, Corporate and other is also comprised of insignificant businesses that do not pertain to other reportable segments.
On September 30, 2019, we completed the sale of 100% of the equity ownership in GAS, which previously constituted the ground support services segment. See Note 2 , Discontinued Operations of Notes to Consolidated Financial Statements included under Part II, Item 8 of this report.
Each business segment has separate management teams and infrastructures that offer different products and services. We evaluate the performance of our business segments based on operating income and Adjusted EBITDA.
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Forward Looking Statements
Certain statements in this Report, including those contained in “Overview,” are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the Company’s financial condition, results of operations, plans, objectives, future performance and business. Forward-looking statements include those preceded by, followed by or that include the words “believes”, “pending”, “future”, “expects,” “anticipates,” “estimates,” “depends” or similar expressions. These forward-looking statements involve risks and uncertainties. Actual results may differ materially from those contemplated by such forward-looking statements, because of, among other things, potential risks and uncertainties, such as:
• Economic conditions in the Company’s markets;
• The risk that contracts with FedEx could be terminated or adversely modified;
• The risk that the number of aircraft operated for FedEx will be reduced;
• The risk that GGS customers will defer or reduce significant orders for deicing equipment;
• The impact of any terrorist activities on United States soil or abroad;
• The Company’s ability to manage its cost structure for operating expenses, or unanticipated capital requirements, and match them to shifting customer service requirements and production volume levels;
• The Company's ability to meet debt service covenants and to refinance existing debt obligations;
• The risk of injury or other damage arising from accidents involving the Company’s overnight air cargo operations, equipment or parts sold and/or services provided;
• Market acceptance of the Company’s commercial and military equipment and services;
• Competition from other providers of similar equipment and services;
• Changes in government regulation and technology;
• Changes in the value of marketable securities held as investments;
• Mild winter weather conditions reducing the demand for deicing equipment;
• Market acceptance and operational success of the Company’s new aircraft asset management business and related new aircraft capital joint venture; and
• The length and severity of the COVID-19 pandemic.
A forward-looking statement is neither a prediction nor a guarantee of future events or circumstances, and those future events or circumstances may not occur. We are under no obligation, and we expressly disclaim any obligation, to update or alter any forward-looking statements, whether as a result of new information, future events or otherwise.
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Results of Operations
Due to insignificance, the Company combined the previous printing and equipment segment into corporate and other. We have presented prior periods based on the current presentation.
Outlook
COVID-19 and its impact on the current financial, economic and capital markets environment, and future developments in these and other areas present uncertainty and risk with respect to our financial condition and results of operations. Each of our businesses implemented measures to attempt to limit the impact of COVID-19 but we still experienced a substantial number of disruptions, and we experienced and continue to experience a reduction in demand for commercial aircraft, jet engines and parts compared to historical periods. Many of our businesses may continue to generate reduced operating cash flow and may operate at a loss during at least the first half of fiscal 2022. We expect that the impact of COVID-19 will continue to some extent. The fluidity of this situation precludes any prediction as to the ultimate adverse impact of COVID-19 on economic and market conditions and our business in particular, and, as a result, present material uncertainty and risk with respect to us and our results of operations.
Fiscal 2021 vs. 2020
Consolidated revenue decreased by $61.7 million (26%) to $175.1 million for the fiscal year ended March 31, 2021 compared to the prior fiscal year. Following is a table detailing revenue (after elimination of intercompany transactions), in thousands:
Year ended March 31, Change
2021 2020
Overnight Air Cargo $ 66,251 $ 75,275 $ (9,024) (12) %
Ground Equipment Sales 60,679 59,156 1,523 3 %
Commercial Jet Engines and Parts 46,793 101,284 (54,491) (54) %
Corporate and Other 1,398 1,070 328 31 %
Total $ 175,121 $ 236,785 $ (61,664) (26) %
Revenues from the air cargo segment decreased by $9.0 million (12%) compared to the prior fiscal year, principally attributable to lower sales to maintenance customers outside of FedEx as a result of COVID-19 and lower admin fees from FedEx due to fewer operating aircraft (66 aircraft in fiscal 2021 compared to 69 aircraft in fiscal 2020). Pass-through costs under the dry-lease agreements with FedEx totaled $19.9 million and $23.7 million for the years ended March 31, 2021 and 2020, respectively.
The ground equipment sales segment contributed approximately $60.7 million and $59.2 million to the Company’s revenues for the fiscal periods ended March 31, 2021 and 2020, respectively, representing a $1.5 million (3%) increase in the current year. The increase was primarily driven by a higher volume of truck sales to the USAF. At March 31, 2021, the ground equipment sales segment’s order backlog was $10.3 million compared to $51.5 million at March 31, 2020.
The commercial jet engines and parts segment contributed $46.8 million of revenues in fiscal year ended March 31, 2021 compared to $101.3 million in the prior fiscal year which is a decrease of $54.5 million (54%). The decrease is primarily attributable to the fact that all the companies within this segment had lower engine and component sales and lease income due to the impact of COVID-19 on the aviation industry as a whole.
Following is a table detailing operating (loss) income by segment, net of intercompany during Fiscal 2021 and Fiscal 2020 (in thousands):
Year ended March 31, Change
2021 2020
Overnight Air Cargo $ 2,178 $ 749 $ 1,429
Ground Equipment Sales 8,948 7,302 1,646
Commercial Jet Engines and Parts (10,882) 8,322 (19,204)
Corporate and Other (9,419) (9,082) (337)
Total $ (9,175) $ 7,291 $ (16,466)
Consolidated operating loss for the fiscal year ended March 31, 2021 was $9.2 million compared to consolidated operating income of $7.3 million in the prior fiscal year.
Operating income for the air cargo segment increased by $1.4 million in the current fiscal year, due primarily to having lower pilot and staff salaries as well as contract labor.
The ground equipment sales segment operating income increased by $1.6 million from $7.3 million in the prior year to $8.9 million in the current year. This increase was primarily attributable to the increased sales noted in the segment revenue discussion above as well as better operating margin as a result of having a more profitable mix of products sold.
Operating loss of the commercial jet engines and parts segment was $10.9 million compared to operating income of $8.3 million in the prior year. The change was primarily attributable to the decreased aircraft engines and component sales as well as reduced lease income due to COVID-19 at the companies within this segment as explained in the segment revenue discussion above. This segment's current year operating loss was also further increased due to inventory write-down of $6.4 million.
Following is a table detailing consolidated non-operating expenses, net of intercompany during Fiscal 2021 and Fiscal 2020 (in thousands):
Year Ended March 31, Change
2021 2020
Other-than-temporary impairment loss on investments $ — $ (2,305) $ 2,305
Interest expense, net (4,624) (4,692) 68
Gain on settlement of bankruptcy — 4,527 (4,527)
Loss from equity method investments (723) (910) 187
Other 2,741 (1,287) 4,028
$ (2,606) $ (4,667) $ 2,061
The Company had net non-operating expenses of $2.6 million for the year ended March 31, 2021, a decrease of $2.1 million from $4.7 million in the prior year. The decrease was primarily due to the prior-year's impairment loss on the investment of Insignia of $2.3 million that did not recur in the current-year as well as an increase of $4.0 million in other income, driven by $2.1 million of investment income and realized gain on sale of securities in the current-year. The decrease was partially offset by the prior-year's gain on settlement of bankruptcy proceedings related to Dephax Canada and UK of $4.5 million that did not recur in the current-year.
During the year ended March 31, 2021, the Company recorded $3.4 million of income tax benefit related to continuing operations, which yielded an effective rate of 28.8%. The primary factors contributing to the difference between the federal statutory rate of 21% and the Company’s effective tax rate for the fiscal year ended March 31, 2021 were the estimated benefit for the exclusion of income for the Company’s captive insurance company subsidiary under §831(b), the exclusion of the minority owned portion of pretax income of Contrail Aviation Support, LLC, state income tax expense, the rate differential for the NOL carryback claim and changes in the valuation allowance. The change in the valuation allowance is primarily due to unrealized losses on investments and the generation of foreign tax credits through the NOL carryback claim that the Company expects to expire before they are fully utilized.
During the fiscal year ended March 31, 2020, the Company recorded $0.5 million of income tax benefit related to continuing operations at an effective tax rate of -20.7%. The primary factors contributing to the difference between the federal statutory rate of 21% and the Company’s effective tax rate for the fiscal year ended March 31, 2020 were the estimated benefit for the exclusion of income for the Company’s captive insurance company subsidiary under §831(b), the exclusion of the minority owned portion of pretax income of Contrail Aviation Support, LLC as well as state income tax expense, and changes in the valuation allowance. The change in the valuation allowance is primarily due to unrealized losses on investments, utilization of capital loss carryforwards, and attribute reduction incurred by Delphax related to cancellation of debt income and dissolution of its Canadian and UK subsidiaries.
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Market Outlook
COVID-19 and its impact on the financial, economic and capital markets environment, and future developments in these and other areas present uncertainty and risk with respect to our financial condition and results of operations. Each of our businesses implemented measures to attempt to limit the impact of COVID-19 but we still experienced a substantial number of disruptions, and a reduction in demand for commercial aircraft, jet engines and parts compared to historical periods. We currently expect that many of our businesses may continue to generate reduced operating cash flow and may operate at a loss during at least the first half of fiscal 2022. We expect that these impacts will continue to some extent. The fluidity of this situation precludes any prediction as to the ultimate adverse impact of COVID-19 on economic and market conditions, and, as a result, present material uncertainty and risk with respect to us and our results of operations.
The outbreak of the COVID-19 virus in the United States and elsewhere created considerable instability and disruption in the U.S. and world economies. Uncertainty still surrounds COVID-19 and its potential effects, as well as the extent and effectiveness of any responses taken on a national and local level. Measures taken to limit the impact of COVID-19, including shelter-in-place orders, social distancing measures and other restrictions on travel, congregation and business operations resulted in significant negative impacts in the United States and world economies and in relation to our business. The long-term impact of COVID-19 on the U.S. and world economies remains uncertain and the duration and scope of the world-wide economic downturn cannot currently be predicted. The extent to which our financial condition, results of operations and overall value will continue to be affected by the COVID-19 pandemic will largely depend on future developments, which are highly uncertain and cannot be accurately predicted, including the scope, severity and duration of the pandemic, the actions taken to contain the pandemic or mitigate its impact, and the direct and indirect economic effects of the pandemic, containment and the effectiveness of vaccine measures, among others.
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Liquidity and Capital Resources
As of March 31, 2021, the Company held approximately $15.9 million in cash and cash equivalents and restricted cash, $4.7 million of which related to restricted cash collateralized for three Opportunity Zone fund investments. The Company also held $1.5 million in restricted investments held as statutory reserve of SAIC. The Company also has approximately $1.4 million of marketable securities.
As of March 31, 2021, the Company’s working capital amounted to $77.6 million, an increase of $46.9 million compared to March 31, 2020, primarily driven by a decrease in short-term borrowings of $37.0 million. See Note 13 of Notes to Consolidated Financial Statements included under Part II, Item 8 of this report for a summary of “Financing Arrangements” as of March 31, 2021.
The Company’s Credit Agreement with Minnesota Bank & Trust, a Minnesota state banking corporation (“MBT”) (the Air T debt in Note 13 of Notes to Consolidated Financial Statements included under Part II, Item 8 of this report) includes several covenants that are measured once a year at March 31, including but not limited to, a negative covenant requiring a debt service coverage ratio of 1.25. The AirCo 1 Credit Agreement (the AirCo 1 debt in Note 13 of Notes to Consolidated Financial Statements included under Part II, Item 8 of this report) contains an affirmative covenant relating to collateral valuation. As of March 31, 2021, the Company and AirCo 1 were in compliance with all financial covenants.
The Contrail Credit Agreement (the Contrail debt in Note 13 of Notes to Consolidated Financial Statements included under Part II, Item 8 of this report) contains affirmative and negative covenants, including covenants that restrict the ability of Contrail and its subsidiaries to, among other things, incur or guarantee indebtedness, incur liens, dispose of assets, engage in mergers and consolidations, make acquisitions or other investments, make changes in the nature of its business, and engage in transactions with affiliates. The Contrail Credit Agreement also contains quarterly financial covenants applicable to Contrail and its subsidiaries, including a minimum debt service coverage ratio of 1.25 to 1.0 and a minimum tangible net worth ("TNW") of $15 million.
On September 25, 2020, Contrail entered into a Third Amendment to Supplement #2 to Master Loan Agreement dated June 24, 2019 with Old National Bank ("ONB"). The material changes within the Third Amendment were: (a) to extend the date for compliance with the provision where Contrail is required to pay down the total outstanding principal balance of its revolver to zero for at least thirty consecutive days to September 5, 2021; and (b) to extend the date for compliance with the required quarterly debt service coverage ratio covenant such that Contrail shall commence compliance with the covenant commencing on March 31, 2022 and on the last day of each fiscal quarter thereafter.
Due primarily to the impact of COVID-19 on its business, as of March 31, 2021, Contrail was not in compliance with maintaining the minimum TNW of $15 million. As of the issuance date of this report, pursuant to the existing terms of the Contrail Credit Agreement, the Company and the non-controlling interest owner of Contrail made total capital contributions to Contrail in the amount of $1.4 million, which had the effect of curing this financial covenant non-compliance. Contrail and ONB are also in discussions to reduce the minimum TNW to $8 million, in exchange for certain amendments to its credit agreement, including renewing its revolving line of credit at a lower amount than the current agreement. However, there is no assurance that Contrail will be successful in reducing the minimum TNW financial covenant.
The obligations of Contrail under the Contrail Credit Agreement are guaranteed by the Company, up to a maximum of $1.6 million, plus costs of collection. The Company is not liable for any other assets or liabilities of Contrail and there are no cross-default provisions with respect to Contrail’s debt in any of the Company’s debt agreements with other lenders. In the possible absence of Contrail’s operation as a going concern, the Company believes it, along with the rest of its businesses, will continue to operate as a going concern, given the maximum guarantee of Contrail’s obligations of $1.6 million.
On November 24, 2020, Contrail and ONB entered into Supplement #8 to Master Loan Agreement and related documentation for a loan in the aggregate amount of $43.6 million for which ONB served as lender pursuant to the Main Street Priority Loan Facility as established by the U.S. Federal Reserve ("the Fed"). The Contrail Main Street Loan was approved by the Fed and completed by December 8, 2020. The proceeds were used to pay down the Contrail Revolver. The loan proceeds are also to be used as working capital to support the operations of Contrail in the ordinary course of business, which includes the acquisition from time to time of aircraft and engines. The indebtedness incurred is subject to the terms and provisions of the Master Loan Agreement. The principal terms of the Contrail Main Street Loan are detailed in Note 13 of Notes to Consolidated Financial Statements included under Part II, Item 8 of this report.
On December 11, 2020, AirCo 1 and Park State Bank ("PSB") entered into a loan in the aggregate amount of $6.2 million for which PSB served as lender pursuant to the Main Street Priority Loan Facility as established by the Fed. The AirCo 1 Main Street Loan was approved by the Fed and completed by December 22, 2020. The loan proceeds were used to pay off the AirCo 1 revolving line of credit with MBT. The principal terms of the Term Loan - PSB are detailed in Note 13 of Notes to Consolidated Financial Statements included under Part II, Item 8 of this report.
The revolving line of credit at Air T with MBT has a due date or expires within the next twelve months. We are currently seeking to refinance this obligation prior to August 31, 2021; however, there is no assurance that we will be able to execute this refinancing or, if we are able to refinance this obligation, that the terms of such refinancing would be as favorable as the terms of our existing credit facility.
In April 2020, the Company obtained loans under the Payroll Protection Program ("PPP loan"), as authorized by the CARES Act, of $8.2 million to help pay for payroll costs, mortgage interest, rent and utility costs. The Company has applied to MBT for forgiveness of the PPP Loan; however, forgiveness is not fully assured.
As mentioned in Note 1 of Notes to Consolidated Financial Statements included under Part II, Item 8 of this report, in 2016, Contrail Aviation entered into an Operating Agreement with the Seller providing for the put and call options with regard to the 21% non-controlling interest retained by the Seller. The Seller is the founder of Contrail Aviation and its current Chief Executive Officer. The Put/Call Option permits the Seller to require Contrail Aviation to purchase all of the Seller’s equity membership interests in Contrail Aviation commencing on the fifth anniversary of the acquisition, which is on July 18, 2021. As of the date of issuance, neither the Seller nor Air T has indicated the intent to exercise its put and call options on July 18, 2021. If either side were to exercise its option, the Company anticipates that the price would approximate the fair value of the Redeemable Non-Controlling Interest, as determined on the transaction date, based on the methodology in Note 1 of Notes to Consolidated Financial Statements included under Part II, Item 8 of this report. The Company currently expects that it would fund any required payment from cash provided by operations.
The Company believes it is probable that the cash on hand (including that obtained from the PPP and other current financings), net cash provided by operations from its remaining operating segments, together with its current revolving lines of credit, as amended or replaced, will be sufficient to meet its obligations as they become due in the ordinary course of business for at least 12 months following the date these financial statements are issued.
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Cash Flows
Following is a table of changes in cash flow from continuing operations for the respective years ended March 31, 2021 and 2020 (in thousands):
Year Ended March 31,
2021 2020 Change
Net Cash Used in Operating Activities $ (1,823) $ (26,231) $ 24,408
Net Cash Provided by (Used in) Investing Activities 2,516 (11,568) 14,084
Net Cash Provided by Financing Activities 71 19,240 (19,169)
Effect of foreign currency exchange rates (412) 260 (672)
Net Increase (Decrease) in Cash and Cash Equivalents and Restricted Cash $ 352 $ (18,299) $ 18,651
Cash used in operating activities was $1.8 million in fiscal year 2021 compared to cash used in operating activities of $26.2 million in fiscal year 2020. During fiscal year 2020, the Company's purchase of engines and components received into inventory exceeded amounts spent in fiscal year 2021 by $23.7 million. Further, more cash was collected this year compared to the prior year as accounts receivable decreased by $6.6 million. The decrease in cash usage was offset by a decrease in net income of $11.6 million due to reduced operations as a result of COVID-19.
Cash provided by investing activities for fiscal year 2021 was $2.5 million compared to cash used in investing activities for the prior fiscal year of $11.6 million. This difference was primarily driven by a net decrease of $32.7 million in capital expenditures, partially offset by $22.5 million less proceeds from sale of assets on lease in fiscal year 2021 compared to fiscal year 2020.
Cash provided by financing activities for fiscal year 2021 was $19.2 million less compared to the prior fiscal year. This was primarily due to decreased net proceeds from lines of credit of $65.9 million, offset by increased net proceeds from term loans of $51.7 million.
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Off-Balance Sheet Arrangements
The Company defines an off-balance sheet arrangement as any transaction, agreement or other contractual arrangement involving an unconsolidated entity under which a Company has (1) made guarantees, (2) a retained or a contingent interest in transferred assets, (3) an obligation under derivative instruments classified as equity, or (4) any obligation arising out of a material variable interest in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the Company, or that engages in leasing, hedging, or research and development arrangements with the Company. The Company is not currently engaged in the use of any of these arrangements.
Impact of Inflation
The Company believes that inflation has not had a material effect on its manufacturing and commercial jet engine and parts operations, because increased costs to date have been passed on to customers. Under the terms of its overnight air cargo business contracts the major cost components of that segment's operations, consisting principally of fuel, crew and other direct operating costs, and certain maintenance costs are reimbursed by its customer. Significant increases in inflation rates could, however, have a material impact on future revenue and operating income.
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Non-GAAP Financial Measures
The Company uses adjusted earnings before taxes, interest, and depreciation and amortization ("Adjusted EBITDA"), a non-GAAP financial measure as defined by the SEC, to evaluate the Company's financial performance. This performance measure is not defined by accounting principles generally accepted in the United States and should be considered in addition to, and not in lieu of, GAAP financial measures.
Adjusted EBITDA is defined as earnings before taxes, interest, and depreciation and amortization, adjusted for specified items. The Company calculates Adjusted EBITDA by removing the impact of specific items and adding back the amounts of interest expense and depreciation and amortization to earnings before income taxes. When calculating Adjusted EBITDA, the Company does not add back depreciation expense for aircraft engines that are on lease, as the Company believes this expense matches with the corresponding revenue earned on engine leases. Depreciation expense for leased engines totaled $1.9 million and $4.4 million for the fiscal year ended March 31, 2021 and 2020.
Management believes that Adjusted EBITDA is a useful measure of the Company's performance because it provides investors additional information about the Company's operations allowing better evaluation of underlying business performance and better period-to-period comparability. Adjusted EBITDA is not intended to replace or be an alternative to operating income from continuing operations, the most directly comparable amounts reported under GAAP.
The table below provides a reconciliation of operating income from continuing operations to Adjusted EBITDA for the fiscal year ended March 31, 2021 and 2020 (in thousands):
Twelve Months Ended
March 31, 2021 March 31, 2020
Operating (loss) income from continuing operations $ (9,175) $ 7,291
Depreciation and amortization (excluding leased engines depreciation) 1,231 1,329
Asset impairment, restructuring or impairment charges 6,592 18
Gain on sale of property and equipment (10) (37)
Security issuance expenses 32 363
Adjusted EBITDA $ (1,330) $ 8,964
Included in the asset impairment, restructuring or impairment charges for the fiscal year ended March 31, 2021 was a write-down of $6.4 million on the commercial jet engines and parts segment's inventory. Of the total write-down, $0.5 million was driven by a management decision to monetize two engines by sale to a third party, in which the net carrying values exceeded the estimated proceeds during the quarter ended September 30, 2020. The remaining write-down was attributable to our evaluation of the carrying value of inventory as of March 31, 2021, where we compared its cost to its net realizable value and considered factors such as physical condition, sales patterns and expected future demand to estimate the amount necessary to write down any slow moving, obsolete or damaged inventory.
The table below provides Adjusted EBITDA by segment for the fiscal year ended March 31, 2021 and 2020 (in thousands):
Twelve Months Ended
March 31, 2021 March 31, 2020
Overnight Air Cargo $ 2,248 $ 821
Ground Equipment Sales 9,132 7,588
Commercial Jet Engines and Parts (3,933) 8,718
Corporate and Other (8,777) (8,163)
Adjusted EBITDA $ (1,330) $ 8,964
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Seasonality
The ground equipment sales segment business has historically been seasonal, with the revenues and operating income typically being higher in the second and third fiscal quarters as commercial deicers are typically delivered prior to the winter season. Other segments are typically not susceptible to material seasonal trends.
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Critical Accounting Policies and Estimates.
The Company’s significant accounting policies are described in Note 1 of Notes to Consolidated Financial Statements included under Part II, Item 8 of this report. The preparation of the Company’s consolidated financial statements in conformity with accounting principles generally accepted in the United States requires the use of estimates and assumptions to determine certain assets, liabilities, revenues and expenses. Management bases these estimates and assumptions upon the best information available at the time of the estimates or assumptions. The Company’s estimates and assumptions could change materially as conditions within and beyond our control change. Accordingly, actual results could differ materially from estimates. The Company believes that the following are its most critical accounting policies:
Inventories – Inventories are carried at the lower of cost or net realizable value. Within the Company’s commercial jet engines and parts segment, there are various estimates and judgments made in relief of inventory as parts are sold from established groups of parts from one engine or airframe purchase. The estimates and judgments made in relief of inventory are based on assumptions that are consistent with a market participant’s future expectations for the commercial aircraft, jet engines and parts industry and the economy in general and our expected intent for the inventory. These assumptions and estimates are complex and subjective in nature. Changes in economic and operating conditions, including those occurring as a result of the impact of the COVID-19 pandemic could impact the assumptions and result in future losses to our inventory.
The Company periodically evaluates the carrying value of inventory. In these evaluations, the Company is required to make estimates regarding the net realizable value, which includes the consideration of sales patterns and expected future demand. Any slow moving, obsolete or damaged inventory and inventory with costs exceeding net realizable value are evaluated for write-downs. These estimates could vary significantly from actual amounts based upon future economic conditions, customer inventory levels, or competitive factors that were not foreseen or did not exist when the estimated write-downs were made.
Valuation of Assets on Lease or Held for Lease - Engine assets on lease or held for lease are stated at cost, less accumulated depreciation. On a quarterly basis, we monitor the portfolio for events which may indicate that a particular asset may need to be evaluated for potential impairment. These events may include a decision to part-out or sell an asset, knowledge of specific damage to an asset, or supply/demand events which may impact the Company’s ability to lease an asset in the future. On an annual basis, even absent any such ‘triggering event’, we evaluate the assets in our portfolio to determine if their carrying amount may not be recoverable. If an asset is determined to be unrecoverable, the asset is written down to fair value. When evaluating for impairment, we test at the individual asset level (e.g., engine, airframe or aircraft), as each asset generates its own stream of cash flows, including lease rents and maintenance reserves.
The Company must make significant and subjective estimates in determining whether any impairment exists. Those estimates are as follows:
• Fair value – we determine fair value by reference to independent appraisals, quoted market prices (e.g., an offer to purchase) and other factors such as current data from airlines, engine manufacturers and MRO providers as well as specific market sales and repair cost data.
• Future cash flows – when evaluating the future cash flows that an asset will generate, we make assumptions regarding the lease market for specific engine models, including estimates of market lease rates and future demand. These assumptions are based upon lease rates that we are obtaining in the current market as well as our expectation of future demand for the specific engine/aircraft model.
If the forecasted undiscounted cash flows and fair value of our long-lived assets decrease in the future, we may incur impairment charges.
Accounting for Redeemable Non-Controlling Interest . Policies related to redeemable non-controlling interest involve judgment and complexity, specifically on the classification of the non-controlling interest in the Company’s consolidated balance sheet. Further, there is significant judgment in determining whether an equity instrument is currently redeemable or not currently redeemable but probable that the equity instrument will become redeemable. Additionally, there are also significant estimates made in the valuation of the redeemable non-controlling interest. The fair value of the non-controlling interest is determined using a combination of the income approach, utilizing a discounted cash flow analysis, and the market approach, utilizing the guideline public company method. Contrail's discounted cash flow analysis requires significant management judgment with respect to forecasts of revenue, operating margins, capital expenditures, and the selection and use of an appropriate discount rate. Contrail’s market approach requires management to make significant assumptions related to market multiples of earnings derived from comparable publicly-traded companies with similar operating characteristics as Contrail.
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Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Not Applicable.
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