AIR T INC 10-Q

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. FORWARD-LOOKING STATEMENTS This section entitled "Management’s Discussion and Analysis of Financial Condition and Results of Operations" (“MD&A”) is intended to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. The MD&A provides a narrative analysis explaining the reasons for material changes in the Company’s (i) financial condition during the period from the most recent fiscal year-end, March 31, 2023, to and including June 30, 2023 and (ii) results of operations during the current fiscal period(s) as compared to the corresponding period(s) of the preceding fiscal year. This Quarterly Report on Form 10-Q, including the MD&A, contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect our current views with respect to future events and financial performance. The words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “forecast,” “project,” “should,” "will," "continue" and similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Any and all forecasts and projections in this document are “forward looking statements” and are based on management’s current expectations or beliefs. From time to time, we may also provide oral and written forward-looking statements in other materials we release to the public, such as press releases, presentations to securities analysts or investors, or other communications by us. Any or all of our forward-looking statements in this report and in any public statements we make could be materially different from actual results. Accordingly, we wish to caution investors that any forward-looking statements made by or on behalf of us are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. We also wish to caution investors that other factors might in the future prove to be important in affecting our results of operations. New factors emerge from time to time; it is not possible for management to predict all of such factors, nor can it assess the impact of each such factor on the business or the extent to which any factor, or a combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We undertake no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 1 of Part 1 of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended March 31, 2023 (including the information presented therein under Risk Factors), as well other publicly available information. 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 insignificant businesses and business interests. 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 First Quarter Fiscal 2024 Compared to First Quarter Fiscal 2023 Consolidated revenue for the three-month period ended June 30, 2023 increased by $20.6 million (40.4%) compared to the same quarter in the prior fiscal year. 26 Following is a table detailing revenue by segment, net of intercompany during the three months ended June 30, 2023 compared to the same quarter in the prior fiscal year (in thousands): Three Months Ended June 30, Change 2023 2022 Overnight Air Cargo $ 27,728 $ 20,564 $ 7,164 34.8 % Ground Equipment Sales 11,787 5,815 5,972 102.7 % Commercial Jet Engines and Parts 29,846 22,855 6,991 30.6 % Corporate and Other 2,070 1,628 442 27.1 % $ 71,431 $ 50,862 $ 20,569 40.4 % Revenues from the air cargo segment for the three-month period ended June 30, 2023 increased by $7.2 million (34.8%) compared to the first quarter of the prior fiscal year. The increase was principally attributable to higher administrative fees due to increased fleet, higher pass-through revenues from FedEx, and the WASI acquisition mentioned in Note 2 of the Notes to Condensed Consolidated Financial Statements of this report, which contributed revenues for a full quarter but was not part of the segment in the 2022 comparable quarter. The ground equipment sales segment contributed approximately $11.8 million and $5.8 million to the Company’s revenues for the three-month periods ended June 30, 2023 and 2022 respectively, representing a $6.0 million (102.7%) increase in the current quarter. The increase was primarily driven by the higher number of deicing trucks sold in the current year quarter compared to prior year's comparable quarter. At June 30, 2023, the ground equipment sales segment’s order backlog was $13.7 million compared to $17.2 million at June 30, 2022. The commercial jet engines and parts segment contributed $29.8 million of revenues in the quarter ended June 30, 2023 compared to $22.9 million in the comparable prior year quarter, which is an increase of $7.0 million (30.6%). The increase was primarily driven by higher component part sales at Contrail in the current quarter compared to prior year comparable quarter. Revenues from the corporate and other segment for the three-month period ended June 30, 2023 increased by $0.4 million (27.1%) compared to the first quarter of the prior fiscal year. The increase was primarily attributable to more subscriptions sales at Shanwick. Following is a table detailing operating income (loss) by segment during the three months ended June 30, 2023 compared to the same quarter in the prior fiscal year (in thousands): Three Months Ended June 30, Change 2023 2022 Overnight Air Cargo $ 1,935 $ 1,077 $ 858 Ground Equipment Sales (85) 142 (227) Commercial Jet Engines and Parts 1,478 3,074 (1,596) Corporate and Other (2,670) (3,459) 789 $ 658 $ 834 $ (176) Consolidated operating income for the quarter ended June 30, 2023 was $0.7 million, compared to an operating income of $0.8 million in the comparable quarter of the prior year. The air cargo segment's operating income for the three-month period ended June 30, 2023 was $1.9 million compared to operating income of $1.1 million in the same quarter in the prior fiscal year primarily due to the revenue increase noted above. The ground equipment sales segment's operating loss for the quarter ended June 30, 2023 was $0.1 million compared the prior year comparable quarter's operating income of $0.1 million. This change was primarily attributable to the increased costs for material, labor, and overhead required to get truck units scheduled and built. The commercial jet engines and parts segment generated operating income of $1.5 million in the current-year quarter compared to operating income of $3.1 million in the prior-year quarter. The decrease was primarily attributable to lower gross profit margins on components sales mentioned above due to parts coming from the tear down of higher priced aircraft. 27 The corporate and other segment's operating loss for the three-month period ended June 30, 2023 was $2.7 million compared to an operating loss of $3.5 million in the same quarter in the prior fiscal year. The change was primarily attributable to the revenue increase mentioned above. Following is a table detailing non-operating income (expense) during the three months ended June 30, 2023 compared to the same quarter in the prior fiscal year (in thousands): Three Months Ended June 30, Change 2023 2022 Interest expense $ (1,808) $ (1,822) $ 14 Income from equity method investments 691 532 159 Other 643 (154) 797 $ (474) $ (1,444) $ 970 The Company had a net non-operating loss of $0.5 million during the quarter ended June 30, 2023, compared to net non-operating loss of $1.4 million in the prior-year quarter. The decrease in non-operating loss was primarily driven by changes in the fair value of the Contrail swap on Term Note G of $0.3 million and the reclassification of previously recorded gain in other comprehensive income into earnings of $0.2 million as the swap was no longer an effective hedge. See Note 8 of the Notes to Condensed Consolidated Financial Statements of this report. In addition, the non-operating loss was further decreased by fluctuations in foreign currency exchange rates causing a gain of $0.1 million in the current year quarter compared to a loss of $0.2 million in the prior year quarter. During the three-month period ended June 30, 2023, the Company recorded $0.2 million in income tax expense at an effective tax rate of 114.7%. 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, 2023 were the change in valuation allowance related to the Company's U.S. consolidated group, Delphax and LGSS, 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 foreign rate differentials for Air T's operations located in the Netherlands, Puerto Rico, and Singapore. During the three-month period ended June 30, 2022, the Company recorded $0.2 million in income tax expense at an effective tax rate of (31.5)%. 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 June 30, 2022 were the change in valuation allowance related to the Company's subsidiaries in the corporate and other segment, Delphax, other capital losses, 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, 2023. 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, 2023. 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. Systems and Network Security Although we have employed significant resources to develop our security measures against breaches, our cybersecurity measures may not detect or prevent all attempts to compromise our systems, including hacking, viruses, malicious software, break-ins, phishing attacks, security breaches or other attacks and similar disruptions that may jeopardize the security of information stored in and transmitted by our systems. Breaches of our cybersecurity measures could result in unauthorized access to our systems, 28 misappropriation of information or data, deletion or modification of client information or other interruption to our business operations. As techniques used to obtain unauthorized access to sabotage systems change frequently and may not be known until launched against us or our third-party service providers, we may be unable to anticipate, or implement adequate measures to protect against these attacks. If we are unable to avert these attacks and security breaches in the future, we could be subject to significant legal and financial liability, our reputation would be harmed and we could sustain substantial revenue loss from lost sales and customer dissatisfaction. We may not have the resources or technical sophistication to anticipate or prevent rapidly evolving types of cyber-attacks. Cyber-attacks may target us or other participants, or the communication infrastructure on which we depend. Actual or anticipated attacks and risks may cause us to incur significantly higher costs, including costs to deploy additional personnel and network protection technologies, train employees, and engage third-party experts and consultants. Cybersecurity breaches would not only harm our reputation and business, but also could materially decrease our revenue and net income. Supply Chain and Inflation Future economic developments such as inflation and increased interest rates as well as further business issues such as supply chain issues 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 and economic and business issues but we still experienced disruptions, and we experienced 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 flows and could operate at a loss from time to time beyond fiscal 2023. We expect that issues caused by the pandemic and other economic and business issue will continue to some extent. The fluidity of this situation precludes any prediction as to the ultimate adverse impact these issues on economic and market conditions and our businesses in particular, and, as a result, presents material uncertainty and risk with respect to us and our results of operations. The Company believes the estimates and assumptions underlying the Company’s consolidated financial statements are reasonable and supportable based on the information available as of June 30, 2023. Liquidity and Capital Resources As of June 30, 2023, the Company held approximately $6.4 million in cash and cash equivalents and restricted cash, $0.2 million of which related to restricted cash collateralized held for three opportunity zone investments made by the Company - 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 $1.6 million in restricted investments held as statutory reserve of SAIC. The Company has approximately $2.5 million of marketable securities and an aggregate of approximately $25.5 million in available funds under its lines of credit as of June 30, 2023. As of June 30, 2023, the Company’s working capital amounted to $63.1 million, a decrease of $10.8 million compared to March 31, 2023 primarily driven by the decrease in short-term debt due to the extension of the Air T revolver's maturity date to August 31, 2024. As mentioned in Note 12 of Notes to Condensed Consolidated Financial Statements included under Part I, Item 1 of this Report on Form 10-Q, on June 23, 2023, the Company and MBT entered into amendments to the MBT revolving credit agreement and related promissory note. The amendments extended the maturity date of the credit facility to August 31, 2024 and include the following changes: 1. A $2.0 million seasonal increase in the maximum amount available under the facility. The maximum amount of the facility will now increase to $19.0 million between May 1 and November 30 of each year and will decrease to $17.0 million between December 1 and April 30 of each year; 2. The reference rate for the interest rate payable on the revolving facility will change from Prime to SOFR, plus a spread. The exact spread over SOFR will change every September 30 and March 31 based on the Company calculated funded debt leverage ratio (defined as total debt divided by EBITDA). Depending on the result of the calculation, the interest rate spread applicable to the facility will range between 2.25% and 3.25%; 3. The unused commitment fee on the revolving credit facility will increase from 0.11% to 0.15%; and, 4. The covenant restricting the Company’s use of funds for “Other Investments” was revised to limit the Company to $5.0 million of “Other Investments” per year. As mentioned in Note 16 of Notes to Condensed Consolidated Financial Statements included under Part I, Item 1 of this Report on Form 10-Q, in 2016, Contrail entered into an Operating Agreement with the Seller providing for the put and call options with regard to the 21.0% 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 or the Company to require Contrail Aviation to purchase all of the Seller’s equity membership interests in Contrail Aviation commencing on July 18, 2021. As of the date of this filing, neither the Seller nor the Company 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 16 of Notes to condensed Consolidated Financial Statements included under Part I, Item 1 of this report, on May 5, 2021, the Company formed CAM and acquired its ownership interest in CAM. The operations of CAM are not consolidated into the operations of the Company. For its Investment Function (as defined in Note 16 of Notes to Consolidated Financial Statements 29 included under Part II, Item 8 of this report), CAM’s initial commitment to CJVII was approximately $51.0 million. The Company and MRC have commitments to CAM in the respective amounts of $7.0 million and $44.0 million. As of June 30, 2023, the Company has fulfilled its capital commitments to CAM. On March 22, 2023, Contrail entered into the First Amendment to Second Amendment to Master Loan Agreement and Third Amendment to Master Loan Agreement ("the Amendment") with ONB whereby, among other things, in exchange for a $20 million principal prepayment of Term Note G, Contrail obtained a waiver of the debt service coverage ratio covenant. $6.7 million of the $20.0 million prepayment was paid on March 30, 2023 and the remaining $13.3 million payment is currently expected to be paid in September 2023. These payments will eliminate the need for Contrail to make any future scheduled principal payments on Term Note G until the final maturity of (on) November 24, 2025. At this time, Contrail management believes it is highly probable that it will have sufficient liquidity to make the $13.3 million prepayment in September 2023. The revolving line of credit at Contrail with ONB has a due date or expires within the next twelve months. We are currently seeking to refinance the Contrail revolver prior to its maturity date; 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. The Company believes it is probable that the cash on hand and 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 for the three months ended June 30, 2023 and 2022 (in thousands): Three Months Ended June 30, 2023 2022 Net Cash Provided by (Used in) Operating Activities $ 3,484 $ (2,531) Net Cash Used in Investing Activities (21) (1,060) Net Cash (Used in) Provided by Financing Activities (4,076) 4,573 Effect of foreign currency exchange rates on cash and cash equivalents (56) 173 Net (Decrease) Increase in Cash and Cash Equivalents and Restricted Cash $ (669) $ 1,155 Net cash provided by operating activities was $3.5 million for the three-month period ended June 30, 2023 compared to net cash used in operating activities of $2.5 million in the prior year three-month period. The change in net cash provided by operating activities was primarily driven by a decrease in inventory of $14.6 million offset by an increase in accounts receivable of $8.6 million due to increased sales in the current quarter. Net cash used in investing activities for the three-month period ended June 30, 2023 was $21.0 thousand compared to net cash used in investing activities of $1.1 million in the prior-year period. The decrease in cash usage in investing activities was primarily driven by less contributions to and more distributions received from unconsolidated entities. Net cash used in financing activities for the three-month period ended June 30, 2023 was $4.1 million compared to net cash provided by financing activities of $4.6 million in the prior-year period. The change in cash usage in financing activities was primarily driven by increased payments on the lines of credit in the current quarter, as well as receipt of proceeds from a term note in the prior quarter that did not recur in the current quarter. 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 30 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. There was no depreciation expense for leased engines for the three months ended June 30, 2023 and $0.3 million for the three months ended June 30, 2022. 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) to Adjusted EBITDA for the three months ended June 30, 2023 and 2022 (in thousands): Three months ended 6/30/2023 6/30/2022 Operating income $ 658 $ 834 Depreciation and amortization (excluding leased engines depreciation) 690 605 Gain on sale of property and equipment (6) (2) Securities expenses 45 15 Adjusted EBITDA $ 1,387 $ 1,452 The table below provides Adjusted EBITDA by segment for the three months ended June 30, 2023 and 2022 (in thousands): Three months ended 6/30/2023 6/30/2022 Overnight Air Cargo $ 2,014 $ 1,096 Ground Equipment Sales (51) 191 Commercial Jet Engines and Parts 1,668 3,251 Corporate and Other (2,244) (3,086) Adjusted EBITDA $ 1,387 $ 1,452