AIR T INC 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Overview Air T, Inc. (the “Company,” “Air T,” “we” or “us”) 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 also comprises of insignificant businesses that do not pertain to other reportable segments. 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. Due to insignificance, the Company combined the previous printing and equipment segment into corporate and other during the quarter ended September 30, 2020. We have presented prior periods based on the current presentation. Results of Operations 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 businesses in particular, and, as a result, present material uncertainty and risk with respect to us and our results of operations. First Quarter Fiscal 2022 Compared to First Quarter Fiscal 2021 Consolidated revenue for the three-month period ended June 30, 2021 was relatively flat compared to the same quarter in the prior fiscal year. Following is a table detailing revenue by segment, net of intercompany during the three months ended June 30, 2021 compared to the same quarter in the prior fiscal year (in thousands): Three Months Ended June 30, Change 2021 2020 Overnight Air Cargo $ 18,851 $ 16,171 $ 2,680 17 % Ground Equipment Sales 8,182 15,828 (7,646) (48) % Commercial Jet Engines and Parts 9,594 4,693 4,901 104 % Corporate and Other 341 278 63 23 % $ 36,968 $ 36,970 $ (2) — % Revenues from the air cargo segment for the three-month period ended June 30, 2021 increased by $2.7 million (17%) compared to the first quarter of the prior fiscal year. The increase was principally attributable to higher pass-through revenue from FedEx as a result 23 of increased business activity versus the prior year quarter as well as higher maintenance revenue from customers outside of FedEx. The ground equipment sales segment contributed approximately $8.2 million and $15.8 million to the Company’s revenues for the three-month periods ended June 30, 2021 and 2020 respectively, representing a $7.6 million (48%) decrease in the current quarter. The decrease was primarily driven by a lower volume of commercial truck sales and ultimate deicers this quarter compared to prior year comparable quarter. At June 30, 2021, the ground equipment sales segment’s order backlog was $7.1 million compared to $48.7 million at June 30, 2020. GGS had a contract to supply deicing trucks to the United States Air Force ("USAF"), which expired on July 13, 2020. GGS has submitted its bid for contract renewal. As of June 30, 2021, the USAF has not yet responded to the bid. The commercial jet engines and parts segment contributed $9.6 million of revenues in the quarter ended June 30, 2021 compared to $4.7 million in the comparable prior year quarter which is an increase of $4.9 million (104%). The increase is primarily attributable to the fact that all the companies within this segment had higher component sales as the aviation industry started to see more activity in the current year quarter as COVID-19 related restrictions continued to loosen. Following is a table detailing operating income (loss) by segment during the three months ended June 30, 2021 compared to the same quarter in the prior fiscal year (in thousands): Three Months Ended June 30, Change 2021 2020 Overnight Air Cargo $ 732 $ 555 $ 177 Ground Equipment Sales 1,423 2,216 (793) Commercial Jet Engines and Parts (238) (902) 664 Corporate and Other (1,921) (2,135) 214 $ (4) $ (266) $ 262 Consolidated operating loss for the quarter ended June 30, 2021 was $4.0 thousand, compared to an operating loss of $0.3 million in the comparable quarter of the prior year. The ground equipment sales segment operating income for the quarter ended June 30, 2021 decreased by $0.8 million from the prior year comparable quarter to $1.4 million. This decrease was primarily attributable to the decreased sales noted in the segment revenue discussion above. The commercial jet engines and parts segment generated an operating loss of $0.2 million in the current-year quarter compared to an operating loss of $0.9 million in the prior-year quarter. The change was primarily attributable to the increased component sales at the companies within this segment as explained in the segment revenue discussion above. Following is a table detailing non-operating income (loss) during the three months ended June 30, 2021 compared to the same quarter in the prior fiscal year (in thousands): Three Months Ended June 30, Change 2021 2020 Interest expense (939) (1,161) 222 Gain (Loss) from equity method investments 83 (558) 641 Other 1,182 729 453 $ 326 $ (990) $ 1,316 The Company had a net non-operating income of $0.3 million for the quarter ended June 30, 2021, compared to a net non-operating loss of $1.0 million in the prior-year quarter. In the first quarter 2020, the Company recorded $0.6 million of net loss pick-up from the investments of Insignia and CCI whereas in the current quarter, we only recorded $0.3 million of net loss pick-up from these investments. Further, in the current quarter, the Company recorded $0.2 million of gain from fair value adjustment related to our Warrants, and $0.5 million of gain from the liquidation of Delphax France, a subsidiary of Delphax Technologies, Inc., in June 2021. During the three-month period ended June 30, 2021, the Company recorded $5.0 thousand in income tax benefit at an effective tax rate ("ETR") of (1.6)%. The Company records income taxes using an estimated annual effective tax rate for interim reporting. The primary factors contributing to the difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the three-month period ended June 30, 2021 were the change in valuation allowance related to Delphax and other capital losses, the estimated 24 benefit for the exclusion of income for the Company's captive insurance company subsidiary ("SAIC") under Section 831(b) and the exclusion from the tax provision of the minority owned portion of the pretax income of Contrail. During the three-month period ended June 30, 2020, the Company recorded $0.3 million in income tax benefit at an ETR of 23.9%. The primary factors contributing to the difference between the federal statutory rate of 21.0% and the Company's effective tax rate for the three-month period ended June 30, 2020 were the change in valuation allowance related to Delphax, the estimated benefit for the exclusion of income for SAIC under Section 831(b) and the exclusion from the tax provision of the minority owned portion of the pretax income of Contrail. Critical Accounting Policies and Estimates The Company’s significant accounting policies are fully described in Note 1 to the condensed consolidated financial statements and in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2021. The preparation of the Company’s condensed 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. There were no significant changes to the Company’s critical accounting policies and estimates during the three-months ended June 30, 2021. Seasonality The ground equipment sales segment business has historically been seasonal, with the revenues and operating income typically being lower in the first and fourth fiscal quarters as commercial deicers are typically delivered prior to the winter season. Other segments have typically not experienced material seasonal trends. Liquidity and Capital Resources As of June 30, 2021, the Company held approximately $11.4 million in cash and cash equivalents and restricted cash, $4.1 million of which related to restricted cash collateralized for Air T OZ 1, LLC, Air T OZ 2, LLC, and Air T OZ 3, LLC (the "Opportunity Zone Funds"), each a Minnesota limited liability company and a subsidiary of the Company. The Company also held $1.0 million in restricted investments held as statutory reserve of SAIC. The Company has approximately $2.4 million of marketable securities and an aggregate of $54.5 million in available funds under its lines of credit as of June 30, 2021. As of June 30, 2021, the Company’s working capital amounted to $79.2 million, an increase of $1.6 million compared to March 31, 2021. The Company’s Credit Agreement with MBT includes several covenants that are measured once a year at March 31, including, but not limited to, a financial covenant requiring a debt service coverage ratio of 1.25. The AirCo 1 Credit Agreement contains an affirmative covenant relating to collateral valuation. The Contrail Credit Agreement 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 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 ONB. The material changes within the Third Amendment are: (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 $0 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. As of June 30, 2021, the Company, AirCo 1 and Contrail were in compliance with all financial covenants. 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. 25 Contrail and ONB are also in discussions to reduce the minimum TNW covenant 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. In April 2020, the Company obtained loans under the PPP loan, backed by the SBA, as authorized by the CARES Act, of $8.2 million to help pay for payroll costs, mortgage interest, rent and utility costs. As of June 30, 2021, the Company has applied to the SBA for forgiveness of the PPP Loan; however, forgiveness is not fully assured. As mentioned in Note 1 3 of Notes to condensed Consolidated Financial Statements included under Part I, Item 1 of this report, in 2016, Contrail 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 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 was on July 18, 2021. As of the date of this filing, neither the Seller nor Air T has indicated the intent to exercise the put and call options. If either side were to exercise the option, the Company anticipates that the price would approximate the fair value of the Contrail RNCI, as determined on the transaction date. The Company currently expects that it would fund any required payment from cash provided by operations. As mentioned in Note 13 of Notes to condensed Consolidated Financial Statements included under Part I, Item 1 of this report, on May 5, 2021, the Company formed a new aircraft asset management business called CAM and a new aircraft capital joint venture called CJVII. The new venture will focus on acquiring commercial aircraft and jet engines for leasing, trading and disassembly. CJVII will target investments in current generation narrow-body aircraft and engines, building on Contrail Aviation’s origination and asset management expertise. CAM will serve two separate and distinct functions: 1) to direct the sourcing, acquisition and management of aircraft assets owned by CJVII, and 2) to directly invest into CJVII alongside other institutional investment partners. CAM has an initial commitment to CJVII of approximately $53 million, which is comprised of an $8 million initial commitment from the Company and an approximately $45 million initial commitment from MRC. As of June 30, 2021, CAM's unfunded capital commitments are approximately $6.9 million from the Company and $43.9 million from MRC. CJVII will initially be capitalized with up to $408 million of equity from the Company and three institutional investor partners, consisting of $108 million in initial commitments and $300 million in upsize capacity, contingent on underwriting and transaction appeal. As of the date of this filing, no capital has been deployed to CJVII and the timing of capital deployment is not yet known at this time. 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. Cash Flows Following is a table of changes in cash flow for the three months ended June 30, 2021 and 2020 (in thousands): Three Months Ended June 30, 2021 2020 Net Cash Used in Operating Activities (8,821) (3,335) Net Cash Used in Investing Activities (1,449) (548) Net Cash Provided by Financing Activities 5,819 5,040 Effect of foreign currency exchange rates on cash and cash equivalents (49) (72) Net (Decrease) Increase in Cash and Cash Equivalents and Restricted Cash (4,500) 1,085 Net cash used in operating activities was $8.8 million for the three-month period ended June 30, 2021 compared to net cash used in operating activities of $3.3 million in the prior year three-month period. The change in net cash used in operating activities was primarily driven by a net change in accounts receivable of ($7.3 million), partially offset by $1.3 million of change in net income (loss). In the current quarter, the Company had a net increase in accounts receivable of $4.7 million compared to a net decrease of $2.6 million in the prior quarter. In addition, the Company had a net income of $0.3 million in the current quarter and a net loss of $1 million in the prior quarter. Both the increase in accounts receivable and net income in the current quarter are attributable to increased sales in the commercial jet engines and parts segment and the air cargo segment as a result of increased activity in the aviation industry due to loosen COVID-19 related restrictions. 26 Net cash used in investing activities for the three-month period ended June 30, 2021 was $1.4 million compared to net cash used in investing activities of $0.5 million in the prior-year period. Cash was used in the current-year period primarily to invest in CAM, the Company's new aircraft asset management business. Net cash provided by financing activities for the three-month period ended June 30, 2021 was $5.8 million compared to net cash provided by financing activities of $5.0 million in the prior-year period. The increase was primarily driven by higher net cash proceeds from the Company's lines of credit and issuance of TruPs, partially offset by lower net cash proceeds from the Company's term loans. 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 $0.1 million and $0.3 million for the three months ended June 30, 2021 and 2020, respectively. 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 (loss), the most directly comparable amounts reported under GAAP. The tables below provide a reconciliation of operating loss to Adjusted EBITDA and Adjusted EBITDA by segment for the three months ended June 30, 2021 and 2020 (in thousands): Three months ended 6/30/2021 6/30/2020 Operating loss $ (4) $ (266) Depreciation and amortization (excluding leased engines depreciation) 279 353 Loss on disposition of assets 3 — Amortization of security issuance expenses 5 — Adjusted EBITDA $ 283 $ 87 Three months ended 6/30/2021 6/30/2020 Overnight Air Cargo $ 747 $ 570 Ground Equipment Sales 1,456 2,284 Commercial Jet Engines and Parts (74) (775) Corporate and Other (1,846) (1,992) Adjusted EBITDA $ 283 $ 87