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. 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 continue to operate at a loss from time to time during the remainder 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. Second Quarter Fiscal 2022 Compared to Second Quarter Fiscal 2021 Consolidated revenue for the three-month period ended September 30, 2021 increased by $7.6 million (21%) 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 September 30, 2021 compared to the same quarter in the prior fiscal year (in thousands): Three Months Ended September 30, Change 2021 2020 Overnight Air Cargo $ 18,847 $ 17,295 $ 1,552 9 % Ground Equipment Sales 9,189 12,060 (2,871) (24) % Commercial Jet Engines and Parts 14,916 6,114 8,802 144 % Corporate and Other 286 135 151 112 % $ 43,238 $ 35,604 $ 7,634 21 % Revenues from the air cargo segment for the three-month period ended September 30, 2021 increased by $1.6 million (9%) compared to the second quarter of the prior fiscal year. The increase was principally attributable to higher maintenance revenue from customers outside of FedEx. The ground equipment sales segment contributed approximately $9.2 million and $12.1 million to the Company’s revenues for the three-month periods ended September 30, 2021 and 2020 respectively, representing a $2.9 million (24%) decrease in the current 25 quarter. The decrease was primarily driven by a lower sales volume of ultimate deicers this quarter compared to prior year comparable quarter. At September 30, 2021, the ground equipment sales segment’s order backlog was $10.9 million compared to $36.8 million at September 30, 2020. On October 22, 2021, GGS was awarded a new contract valued at approximately $34.0 million to supply deicing trucks to the United States Air Force ("USAF"). The contract award is for two years with four additional one-year extension options that may be exercised by the USAF. The commercial jet engines and parts segment contributed $14.9 million of revenues in the quarter ended September 30, 2021 compared to $6.1 million in the comparable prior year quarter, which is an increase of $8.8 million (144%). 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 September 30, 2021 compared to the same quarter in the prior fiscal year (in thousands): Three Months Ended September 30, Change 2021 2020 Overnight Air Cargo $ 857 $ 573 $ 284 Ground Equipment Sales 43 924 (881) Commercial Jet Engines and Parts 1,902 (2,275) 4,177 Corporate and Other (2,098) (2,906) 808 $ 704 $ (3,684) $ 4,388 Consolidated operating income for the quarter ended September 30, 2021 was $0.7 million, compared to an operating loss of $3.7 million in the comparable quarter of the prior year. The air cargo segment's operating income for the three-month period ended September 30, 2021 increased by $0.3 million compared to the second quarter of the prior fiscal year. The increase was primarily driven by higher maintenance revenue from customers outside of FedEx offset by higher salaries. The ground equipment sales segment's operating income for the quarter ended September 30, 2021 decreased by $0.9 million from the prior year comparable quarter to $43.0 thousand. 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 income of $1.9 million in the current-year quarter compared to an operating loss of $2.3 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. The corporate and other segment's operating loss was $0.8 million less this quarter compared to prior year's comparable quarter. The decrease was primarily attributable to lower health insurance claims during the three months ended September 30, 2021 compared to September 30, 2020. Following is a table detailing non-operating income (loss) during the three months ended September 30, 2021 compared to the same quarter in the prior fiscal year (in thousands): Three Months Ended September 30, Change 2021 2020 Interest expense (1,167) (1,081) (86) Gain (Loss) from equity method investments 14 (498) 512 Gain on forgiveness of Paycheck Protection Program (“PPP”) loan 8,331 — 8,331 Other 159 359 (200) $ 7,337 $ (1,220) $ 8,557 The Company had a net non-operating income of $7.3 million for the quarter ended September 30, 2021, compared to a net non-operating loss of $1.2 million in the prior-year quarter. In the second quarter 2020, the Company recorded $0.5 million of net loss from our equity investments whereas in the current quarter, we recorded $14.0 thousand of net income pick-up. Further, in the current quarter, the Company recorded $8.3 million of gain from the SBA's forgiveness of our PPP loan. 26 During the three-month period ended September 30, 2021, the Company recorded $38.0 thousand in income tax expense at an ETR of 0.5%. 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 September 30, 2021 were the change in valuation allowance related to Delphax and other capital losses, the estimated benefit for the exclusion of income for SAIC under Section 831(b), the exclusion from the tax provision of the minority owned portion of the pretax income of Contrail, and the exclusion from taxable income of the PPP loan forgiveness income, as directed by the CARES Act enacted in 2020, and any accrued interest forgiven as a part of that Act. During the three-month period ended September 30, 2020, the Company recorded $1.5 million in income tax benefit at an ETR of 31.5%. 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 September 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. First Six Months of Fiscal 2021 Compared to First Six Months of Fiscal 2020 Following is a table detailing revenue by segment (in thousands): Six Months Ended September 30, Change 2021 2020 Overnight Air Cargo $ 37,697 $ 33,466 $ 4,231 13 % Ground Equipment Sales 17,371 27,888 (10,517) (38) % Commercial Jet Engines and Parts 24,510 10,808 13,702 127 % Corporate and Other 628 414 214 52 % $ 80,206 $ 72,576 $ 7,630 11 % Revenues from the air cargo segment for the six months ended September 30, 2021 increased by $4.2 million (13%) compared to the six months ended September 30, 2020. The increase was principally attributable to higher pass-through revenue from FedEx as a result 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 $17.4 million and $27.9 million to the Company’s revenues for the six-month periods ended September 30, 2021 and 2020 respectively, representing a $10.5 million (38)% decrease in the current six-month period. The decrease was primarily driven by a lower sales volume of ultimate deicers and catering trucks in the current year compared to prior year. The commercial jet engines and parts segment contributed $24.5 million of revenues in the six months ended September 30, 2021 compared to $10.8 million in the comparable prior year six months. 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 as COVID-19 related restrictions continued to loosen. Following is a table detailing operating income (loss) by segment during the six months ended September 30, 2021 compared to the same six months in the prior fiscal year (in thousands): Six Months Ended September 30, Change 2021 2020 Overnight Air Cargo $ 1,589 $ 1,127 $ 462 Ground Equipment Sales 1,465 3,140 (1,675) Commercial Jet Engines and Parts 1,664 (3,177) 4,841 Corporate and Other (4,019) (5,039) 1,020 $ 699 $ (3,949) $ 4,648 Consolidated operating income for the six months ended September 30, 2021 was $0.7 million compared to an operating loss of $3.9 million for the comparable six months of the prior year. Operating income for the air cargo segment for the six months ended September 30, 2021 increased by $0.5 million versus the prior year comparable period primarily due to the revenue increase noted above. 27 The ground equipment sales segment operating income decreased by $1.7 million to $1.5 million in the six-month period ended September 30, 2021 versus the prior year comparable period. This decrease was primarily attributable to the revenue decrease noted above. The commercial jet engines and parts segment generated an operating income of $1.7 million in the current-year six month period compared to an operating loss of $3.2 million in the prior-year six-month period. The change was primarily attributable to the increased component sales as the aviation industry started to see more activity as explained in the segment revenue discussion above. Following is a table detailing non-operating income (loss) during the six months ended September 30, 2021 compared to the same six months in the prior fiscal year (in thousands): Three Months Ended September 30, Change 2021 2020 Interest expense (2,105) (2,242) $ 137 Gain (Loss) from equity method investments 97 (1,056) 1,153 Gain on forgiveness of PPP loan 8,331 — 8,331 Other 1,340 1,086 254 7,663 (2,212) $ 9,875 The Company had a net non-operating income of $7.7 million for the six months ended September 30, 2021 compared to a net non-operating loss of $2.2 million in the prior-year six-month period. The increase was primarily attributable to the $8.3 million gain recognized on the SBA's forgiveness of the Company's PPP loan. In addition, in the prior year, the Company recorded $1.1 million of net loss from our equity investments whereas in the current year, we recorded $97.0 thousand of net income from these investments. During the six-month period ended September 30, 2021, the Company recorded $33.0 thousand in income tax expense at an effective rate of 0.4%. 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 six-month period ended September 30, 2021 were the change in valuation allowance related to Delphax, the estimated benefit for the exclusion of income for SAIC under Section 831(b), the exclusion from the tax provision of the minority owned portion of the pretax income of Contrail, the exclusion from taxable income of the PPP loan forgiveness income, as directed by the CARES Act enacted in 2020, and any accrued interest forgiven as a part of that Act. During the six-month period ended September 30, 2020, the Company recorded $1.8 million in income tax benefit which resulted in an effective tax rate of 30.0%. The primary factors contributing to the difference between the federal statutory rate and the Company's effective tax rate for the six-month period ended September 30, 2020 were related to 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 September 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 28 As of September 30, 2021, the Company held approximately $6.3 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 $0.8 million in restricted investments held as statutory reserve of SAIC. The Company has approximately $2.8 million of marketable securities and an aggregate of $37.2 million in available funds under its lines of credit as of September 30, 2021. As of September 30, 2021, the Company’s working capital amounted to $96.8 million, an increase of $19.2 million compared to March 31, 2021. On August 31, 2021, Air T entered into a Third Amended and Restated Credit Agreement with MBT. The terms of the Amended and Restated Credit Agreement were revised to extend the Air T revolver's termination date to August 31, 2023. The maximum amount available under the revolving facility remains at $17 million and interest will be due on the outstanding balance at the rate of 2.5% or the prime rate plus 1%, whichever is greater. At September 30, 2021, there was $12.3 million available under this revolving credit agreement. Air T and MBT also revised Term Note A to extend the maturity date to August 30, 2031 and to increase the principal amount to $9 million. The revised note utilizes a fixed 3.42% interest rate. Air T and MBT also revised Term Note B to extend the maturity date to August 30, 2031. The principal balance was set at the then current balance amount of $3.2 million. The interest rate on Term Note B is fixed at 3.42%. A prepayment penalty provision was added to Term Note A and Term Note B that provides for a 3% premium payment if prepayment occurs in year 1, 1% in years 2-3 and 0% thereafter. 20% of the loan amount can be prepaid without penalty each year and no penalty payment is due for prepayments made to cure a covenant violation. Term Note E was restated to set the principal amount of the note at the then current balance due amount ($3.7 million), which amount reflects principal payments through August 31, 2021. The parties also agreed to add the Company’s indirect subsidiary, Jet Yard as a co-Borrower. Jet Yard entered into a promissory note with MBT in the principal amount of $2 million. The Jet Yard Note matures on August 30, 2031, has a fixed interest rate of 4.14% and amortizes over a 15 year period. Jet Yard intends to use the proceeds of the note for leasehold improvements at Jet Yard’s facility in Marana, AZ. On September 2, 2021, Contrail entered into a Fourth Amendment to Supplement #2 to Master Loan Agreement and Third Amended and Restated Promissory Note Revolving Note with ONB. The principal revisions to Contrail’s existing credit facility with ONB as contained in the Amendment and the Restated Promissory Note Revolving Note are summarized below: a. The termination date of the facility was extended to September 5, 2023; b. The Revolving Note principal amount was revised from $40 million to $25 million; c. The net worth covenant was amended and the definition of “net worth” was revised. The net worth covenant now requires that the borrower maintain a net worth of at least: (i) $8 million at all times prior to March 31, 2023; (ii) $10 million at all times during the period beginning March 31, 2023 and ending on March 30, 2024; and (iii) $12 million at all times on or after March 31, 2024. At September 30, 2021, there was $24.9 million available under this ONB revolving credit facility. On April 13, 2020, the Company entered into a loan with MBT with a principal amount of $8.2 million pursuant to the Payroll Protection Program ("PPP Loan"), backed by the Small Business Administration ("SBA"), under the CARES Act. As of September 30, 2021, the Company's PPP Loan was fully forgiven by the SBA. As such, the Company accounted for its then outstanding principal and accrued interest as a gain on extinguishment in accordance with ASC 470. As mentioned in Note 13 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 an 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 29 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 $8.0 million initial commitment from the Company and an approximately $45.0 million initial commitment from MRC. As of September 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 $408.0 million of equity from the Company and three institutional investor partners, consisting of $108.0 million in initial commitments and $300.0 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 amounts forgiven under the PPP loan and other current financings), net cash provided by operations from its remaining operating segments, together with amounts available under our current revolving lines of credit, as amended, 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 from continuing operations for the six months ended September 30, 2021 and 2020 (in thousands): Six Months Ended September 30, 2021 2020 Net Cash Used in Operating Activities (22,753) (5,626) Net Cash Used in Investing Activities (2,376) (615) Net Cash Provided by Financing Activities 15,425 3,662 Effect of foreign currency exchange rates on cash and cash equivalents 51 (127) Net Decrease in Cash and Cash Equivalents and Restricted Cash (9,653) (2,706) Net cash used in operating activities was $22.8 million for the six-month period ended September 30, 2021 compared to net cash used in operating activities of $5.6 million in the prior year six-month period. The change in net cash used in operating activities was primarily driven by a net change in accounts receivable of $12.8 million, in addition to a net change in inventories of $8.2 million and the gain on forgiveness of PPP loan of $8.3 million, partially offset by $12.6 million of change in net income (loss). In the current period, the Company had a net increase in accounts receivable of $10.6 million compared to a net decrease of $2.2 million in the prior period. In addition, the Company had a net increase in inventories of $10.1 million in the current period and a net increase of $1.9 million in the prior period. Both the increase in accounts receivable and inventories in the current period 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 the loosening of COVID-19 related restrictions. Net cash used in investing activities for the six-month period ended September 30, 2021 was $2.4 million compared to net cash used in investing activities of $0.6 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 and to make improvements on Jet Yard's ground hardening. Net cash provided by financing activities for the six-month period ended September 30, 2021 was $15.4 million compared to net cash provided by financing activities of $3.7 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 30 revenue earned on engine leases. Depreciation expense for leased engines totaled $18.3 thousand and $0.8 million for the three months ended September 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 income (loss) from continuing operations to Adjusted EBITDA and Adjusted EBITDA by segment for the three and six months ended September 30, 2021 and 2020 (in thousands): Three months ended Six months ended 9/30/2021 9/30/2020 9/30/2021 9/30/2020 Operating income (loss) from continuing operations $ 704 $ (3,684) $ 699 $ (3,949) Depreciation and amortization (excluding leased engines depreciation) 304 305 584 658 Asset impairment, restructuring or impairment charges — 664 — 664 Loss/(Gains) on disposition of assets — (3) 3 (4) Security issuance expenses 60 — 65 — Adjusted EBITDA $ 1,068 $ (2,718) $ 1,351 $ (2,631) Three months ended Six months ended 9/30/2021 9/30/2020 9/30/2021 9/30/2020 Overnight Air Cargo $ 871 $ 596 $ 1,617 $ 1,166 Ground Equipment Sales 74 970 1,531 3,254 Commercial Jet Engines and Parts 2,098 (1,614) 2,024 (2,390) Corporate and Other (1,975) (2,670) (3,821) (4,661) Adjusted EBITDA $ 1,068 $ (2,718) $ 1,351 $ (2,631) Item 3. Quantitative and Qualitative Disclosures About Market Risk. The Company is exposed to various risks, including interest rate risk. As interest rates are projected to increase and can be volatile, the Company has designated a risk management policy which permits the use of derivative instruments to provide protection against rising interest rates on variable rate debt.