MESA AIR GROUP INC - Quarter Report: 2018 June (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

OR

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                      TO                     .

Commission File Number 001-38626

 

 

MESA AIR GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Nevada		85-0302351
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
410 North 44th Street, Suite 700 Phoenix, Arizona 85008		85008
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (602) 685-4000

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		☐		Accelerated filer		☐
Non-accelerated filer		☒  (Do not check if a smaller reporting company)		Smaller reporting company		☐
				Emerging growth company		☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of August 31, 2018, the registrant had 23,123,240 shares of common stock, no par value per share, issued and outstanding.

 

 

 

TABLE OF CONTENTS

 

PART I – FINANCIAL INFORMATION			2
Item 1. Financial Statements			2
Condensed Consolidated Balance Sheets			2
Condensed Consolidated Statements of Operations			3
Condensed Consolidated Statements of Cash Flows			4
Notes to Condensed Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			18
Item 3. Quantitative and Qualitative Disclosures About Market Risk			30
Item 4. Controls and Procedures			31
PART II – OTHER INFORMATION			32
Item 1. Legal Proceedings			32
Item 1A. Risk Factors			32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			48
Item 3. Defaults Upon Senior Securities			48
Item 4. Mine Safety Disclosures			48
Item 5. Other Information			48
Item 6. Exhibits			48
SIGNATURES			50

Where You Can Find More Information

Investors and others should note that we may announce material business and financial information to our investors using our investor relations website (http://investor.mesa-air.com/), SEC filings, webcasts, press releases, and conference calls. We use these mediums, including our website, to communicate with our members and public about our company, our products, and other issues. It is possible that the information that we make available may be deemed to be material information. We therefore encourage investors and others interested in our company to review the information that we make available on our website.

 

Cautionary Note Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, business strategy and plans, and objectives of management for future operations, are forward-looking statements. These statements involve known and unknown risks, uncertainties, and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance, or achievements expressed or implied by the forward-looking statements.

In some cases, you can identify forward-looking statements by terms such as “may,” “should,” “expects,” “might,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” “seek,” “would” or “continue,” or the negative of these terms or other similar expressions. The forward-looking statements in this Quarterly Report on Form 10-Q are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. These forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and are subject to a number of risks, uncertainties and assumptions described in the “Risk Factors” section and elsewhere in this Quarterly Report on Form 10-Q. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely on these forward-looking statements as predictions of future events. The events and circumstances reflected in our forward-looking statements may not be achieved or occur and actual results could differ materially from those projected in the forward-looking statements. Some of the key factors that could cause actual results to differ from our expectations include:

 

•

the supply and retention of qualified airline pilots;

 

•

the volatility of pilot attrition;

 

•

dependence on, and changes to, or non-renewal of, our capacity purchase agreements;

 

•

increases in our labor costs;

 

•

reduced utilization (the percentage derived from dividing (i) the number of block hours actually flown during a given month under a particular capacity purchase agreement by (ii) the maximum number of block hours that could be flown during such month under the particular capacity purchase agreement) under our capacity purchase agreements;

 

•

direct operation of regional jets by our major airline partners;

 

•

the financial strength of our major airline partners;

 

•

limitations on our ability to expand regional flying within the flight systems of our major airline partners’ and those of other major airlines;

 

•

our significant amount of debt and other contractual obligations;

 

•

our compliance with ongoing financial covenants under our credit facilities; and

 

•

our ability to keep costs low and execute our growth strategies.

While we may elect to update these forward-looking statements at some point in the future, whether as a result of any new information, future events, or otherwise, we have no current intention of doing so except to the extent required by applicable law.

 

1

Part I – Financial Information

Item 1. Financial Statements

MESA AIR GROUP, INC.

Condensed Consolidated Balance Sheets

(In thousands) (Unaudited)

 

		June 30,				September 30,
		2018				2017
ASSETS
Current assets:
Cash and cash equivalents		$	41,731			$	56,788
Restricted cash			3,823				3,559
Receivables, net ($1,098 and $1,329 from related party)			21,596				8,853
Expendable parts and supplies, net			15,716				15,114
Prepaid expenses and other current assets			39,502				61,525
Total current assets			122,368				145,839
Property and equipment, net			1,239,548				1,192,448
Intangibles, net			11,437				11,724
Lease and equipment deposits			4,618				1,945
Other assets			11,611				5,693
Total assets		$	1,389,582			$	1,357,649
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of long-term debt		$	149,936			$	140,466
Accounts payable ($845 and $2,644 to related party)			44,654				44,738
Accrued compensation			23,638				9,080
Other accrued expenses			28,649				23,929
Total current liabilities			246,877				218,213
Long-term debt, excluding current portion			828,487				803,874
Deferred credits ($6,294 and $7,370 to related party)			14,657				17,189
Deferred income taxes			33,632				56,436
Other noncurrent liabilities			33,306				39,713
Total noncurrent liabilities			910,082				917,212
Total liabilities			1,156,959				1,135,425
Commitments and contingencies (Note 13 and Note 14)
Stockholders’ equity:
Preferred stock of no par value, 5,000,000 shares authorized; no shares issued and outstanding			—				—
Common stock of no par value and additional paid-in capital, 125,000,000 shares authorized; 12,572,630 (2018) and 11,294,083 (2017) shares issued and outstanding, and 10,871,730 (2018) and 12,230,625 (2017) warrants issued and outstanding			112,732				114,456
Retained earnings			119,891				107,768
Total stockholders’ equity			232,623				222,224
Total liabilities and stockholders’ equity		$	1,389,582			$	1,357,649

See accompanying notes to these condensed consolidated financial statements.

 

2

MESA AIR GROUP, INC.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts) (Unaudited)

 

		Three Months Ended June 30,								Nine Months Ended June 30,
		2018				2017				2018				2017
Operating revenues:
Contract revenue (2018—$90,834 and $266,037 and 2017—$92,380 and $275,367 from related party)		$	159,916			$	157,410			$	470,820			$	467,121
Pass-through and other (2018—$1,634 and $4,989 and 2017—$892 and $3,748 from related party)			11,823				9,542				33,243				19,161
Total operating revenues			171,739				166,952				504,063				486,282
Operating expenses:
Flight operations			51,795				37,953				155,602				110,302
Fuel			151				214				349				614
Maintenance			48,290				46,817				154,046				164,239
Aircraft rent			17,975				18,274				54,557				54,334
Aircraft and traffic servicing			848				1,178				2,592				2,758
General and administrative			22,066				10,534				43,333				31,210
Depreciation and amortization			16,013				15,620				47,611				45,220
Lease termination			15,109				—				15,109				—
Total operating expenses			172,247				130,590				473,199				408,677
Operating (loss) income			(508	)			36,362				30,864				77,605
Other (expenses) income, net:
Interest expense			(14,118	)			(11,819	)			(41,592	)			(33,659	)
Interest income			11				8				30				23
Other expense			(15	)			(53	)			(117	)			(447	)
Total other (expense), net			(14,122	)			(11,864	)			(41,679	)			(34,083	)
(Loss) income before taxes			(14,630	)			24,498				(10,815	)			43,522
Income tax (benefit) expense			(3,495	)			9,065				(24,676	)			16,175
Net (loss) income		$	(11,135	)		$	15,433			$	13,861			$	27,347
Net (loss) income per share attributable to common shareholders
Basic		$	(0.89	)		$	1.40			$	1.18			$	2.52
Diluted		$	(0.89	)		$	0.66			$	0.58			$	1.18
Weighted-average common shares outstanding
Basic			12,462				10,993				11,782				10,852
Diluted			12,462				23,223				24,052				23,241

See accompanying notes to these condensed consolidated financial statements.

 

3

MESA AIR GROUP, INC.

Condensed Consolidated Statements of Cash Flows

(In thousands) (Unaudited)

 

		Nine Months Ended June 30,
		2018				2017
Cash Flows From Operating Activities:
Net income		$	13,861			$	27,347
Adjustments to reconcile net income to net cash flows provided by operating activities:
Depreciation and amortization			47,611				45,220
Stock compensation expense			1,209				885
Deferred income taxes			(22,139	)			16,190
Amortization of unfavorable lease liabilities and deferred credits			(8,295	)			(7,928	)
Amortization of debt financing costs and accretion of interest on non-interest-bearing subordinated notes			3,577				1,328
Loss on disposal of assets			276				488
Provision for obsolete expendable parts and supplies			74				349
Loss on contract termination			15,109				—
Provision for doubtful accounts			—				(86	)
Changes in assets and liabilities:
Receivables			(12,743	)			(6,529	)
Expendable parts and supplies			(677	)			(2,265	)
Prepaid expenses and other current assets			4,727				(14,773	)
Accounts payable			8,361				(24,584	)
Accrued liabilities			12,212				3,098
Net cash provided by operating activities			63,163				38,740
Cash Flows From Investing Activities:
Capital expenditures			(98,509	)			(64,819	)
Proceeds from sale of rotable spare parts			—				18
Deposit of restricted cash			(264	)			(69	)
Net payments of lease and equipment deposits			(2,673	)			(2,789	)
Net cash used in investing activities			(101,446	)			(67,659	)
Cash Flows From Financing Activities:
Proceeds from long-term debt			187,703				133,460
Principal payments on long-term debt and capital leases			(158,170	)			(116,139	)
Debt financing costs			(5,767	)			(2,365	)
Repurchase of stock			(540	)			(803	)
Net cash provided by financing activities			23,226				14,153
Net change in cash and cash equivalents			(15,057	)			(14,766	)
Cash and cash equivalents at beginning of period			56,788				37,686
Cash and cash equivalents at end of period		$	41,731			$	22,920

See accompanying notes to these condensed consolidated financial statements.

 

4

MESA AIR GROUP, INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.	Organization and Operations

The Company

Mesa Air Group, Inc. (“Mesa” or the “Company”) is a holding company whose principal subsidiary operates as a regional air carrier, providing scheduled passenger service. As of June 30, 2018, the Company served 115 cities in 38 states, the District of Columbia, Canada, Mexico, and the Bahamas and operated a fleet of 145 aircraft with approximately 600 daily departures.

The Company’s airline operations are conducted by its regional airline subsidiary, Mesa Airlines, Inc. (“Mesa Airlines”), providing services to major air carriers under capacity purchase agreements. Mesa Airlines operates as American Eagle under a capacity purchase agreement with American Airlines, Inc. (“American”) and as United Express under a capacity purchase agreement with United Airlines, Inc. (“United”). All of the Company’s condensed consolidated contract revenues for three months ended June 30, 2018 and 2017 and nine months ended June 30, 2018 and 2017 were derived from operations associated with these two capacity purchase agreements.

The financial arrangements between the Company and its major airline partners involve a revenue-guarantee arrangement whereby the major airline pays a monthly guaranteed amount for each aircraft under contract, a fixed fee for each block hour and flight flown and reimbursement of certain direct operating expenses in exchange for providing regional flying. The major airline partners also pay certain expenses directly to suppliers, such as fuel, ground operations and certain landing fees. Under the terms of these capacity purchase agreements, the major airline controls route selection, pricing and seat inventories, thereby reducing the Company’s exposure to fluctuations in passenger traffic, fare levels, and fuel prices.

On August 14, 2018, the Company completed an initial public offering (“IPO”) of its common stock, in which it issued and sold 9,630,000 shares of common stock at a public offering price of $12.00 per share, resulting in gross proceeds to the Company of approximately $115.6 million. Additionally, in connection with the IPO, the Company granted the underwriters an option to purchase up to an additional 777,833 shares of common stock at the same price, which has not been exercised as of September 4, 2018, the issuance date of the interim financial statements. As part of the IPO, stock appreciation rights (“SARs”) previously issued under the Mesa Air Group, Inc. Amended and Restated Stock Appreciation Rights Plan (the “SAR Plan”), which settled only in cash, were cancelled and exchanged for an aggregate of 1,266,034 shares of restricted common stock under the Company’s 2018 Equity Incentive Plan (the “2018 Plan”) (see note 12), of which 966,022 were fully vested upon issuance and are included in the number of shares of common stock outstanding after the IPO. Of the 966,022 fully vested shares, 314,198 shares were retained by the Company to satisfy tax withholding obligations, resulting in a net issuance of 651,824 shares.

American Capacity Purchase Agreement

As of June 30, 2018, the Company operated 64 CRJ-900 aircraft for American under a capacity purchase agreement. Unless otherwise extended or amended, the capacity purchase agreement for the aircraft expires between 2021 and 2025. In exchange for providing flights and all other services under the agreement, the Company receives a fixed monthly minimum amount per aircraft, plus certain additional amounts based upon the number of flights and block hours (the number of hours during which the aircraft is in revenue service, measured from the time of gate departure before take-off until the time of gate arrival at the destination) flown during the month. In addition, the Company may also receive incentives or pay penalties based upon the Company’s operational performance, including controllable on-time departure and controllable completion percentages. American also reimburses the Company for the actual amount incurred for certain items such as passenger liability and hull insurance, and aircraft property taxes. In addition, American also provides, at no cost to the Company, certain ground handling and customer service functions, as well as airport-related facilities and fuel. The Company also receives a monthly profit margin payment from American based on the number of aircraft operating. The capacity purchase agreement is subject to early termination for cause under specified circumstances and subject to the Company’s right to cure under certain conditions. American has a 10.7% ownership interest in the Company, calculated on a fully-diluted basis. The related party amounts presented on the condensed consolidated balance sheets and statements of operations pertain to American.

 

5

United Capacity Purchase Agreement

As of June 30, 2018, the Company operated 20 CRJ-700 and 60 E-175 aircraft for United under a capacity purchase agreement. Subject to certain early termination rights, the capacity purchase agreement for each of the 20 CRJ-700 aircraft expires between August and December 2019. Subject to early termination rights, the capacity purchase agreement for 30 of the E-175 aircraft (owned by United) expires between June 2019 and August 2020, subject to United’s right to extend for four additional two-year terms (maximum of eight years). Subject to early termination rights, the capacity purchase agreement for 18 of the E-175 aircraft (owned by Mesa) expires between January 2028 and November 2028. During fiscal 2017, the Company and United expanded the capacity purchase agreement to include an additional 12 E-175 aircraft (purchased by United) with the aircraft entering service through January 2018 for five-year terms, subject to United’s right to extend for four additional two-year terms (maximum of eight years). In exchange for performing the flight services under such agreement, the Company receives from United a fixed monthly minimum amount per aircraft, plus certain additional amounts based upon the number of flights and block hours flown during the month. Additionally, certain costs incurred by the Company in performing the flight services are “pass-through” costs, whereby United agrees to reimburse the Company for the actual amounts incurred for the following items: property tax per aircraft, landing fees, and additionally for the E-175 aircraft owned by United, heavy airframe and engine maintenance, landing gear, APUs and component maintenance. The Company also receives a profit margin based upon certain reimbursable costs under the agreement, as well as its operational performance in addition to a fixed profit margin. The capacity purchase agreement is also subject to early termination for cause under specified circumstances and subject to the Company’s right to cure under certain circumstances.

In February 2018, the Company mutually agreed with United to temporarily remove two aircraft from service under its United capacity purchase agreement until the Company was able to fully staff flight operations. During the temporary removal, the Company agreed to pay the lease costs associated with the two E-175 aircraft, which totaled $1.9 million as of June 30, 2018. In June 2018, the Company mutually agreed with United to place two E-175 aircraft back into service under the United capacity purchase agreement that were temporarily removed.

 

2.	Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of the Company and its wholly owned operating subsidiaries. Any reference in these notes to applicable guidance is meant to refer to the authoritative United States generally accepted accounting principles as found in the Accounting Standards Codification (“ASC”) and Accounting Standards Update (“ASU”) of the Financial Accounting Standards Board (“FASB”). All intercompany accounts and transactions have been eliminated in consolidation.

These condensed consolidated financial statements have been derived from, and should be read in conjunction with, the Company’s audited consolidated financial statements and notes thereto as of and for the year ended September 30, 2017 included in the Company’s Registration Statement on Form S-1, File No. 333-226173 on file with the U.S. Securities and Exchange Commission (the “SEC”). There have not been any significant changes to the Company’s significant accounting policies during the nine months ended June 30, 2018, except for the valuation of stock compensation at fair value. Information and footnote disclosures normally included in financial statements have been condensed or omitted in these condensed consolidated financial statements pursuant to the rules and regulations of the SEC and GAAP. These condensed consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary to present fairly the results of operations for the interim periods presented.

The Company is an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and may remain an emerging growth company until the last day of the fiscal year following the fifth anniversary of the IPO, subject to specified conditions. The JOBS Act provides that an emerging growth company can take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards. The Company has elected to “opt out” of such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, the Company will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

Use of Estimates

The preparation of the Company’s condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses and the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements. Actual results could differ from those estimates.

 

6

Rental Income

The amount deemed to be rental income for the three months ended June 30, 2018 and 2017 was $53.5 million and $54.5 million, respectively, and for the nine months ended June 30, 2018 and 2017 was $162.0 million and $163.0 million, respectively. Rental income has been included in contract revenue on the Company’s condensed consolidated statements of operations. The Company has not separately stated aircraft rental income and aircraft rental expense in the condensed consolidated statements of operations since the use of the aircraft is not a separate activity of the total service provided.

Maintenance Expense

The Company operates under a Federal Aviation Administration (“FAA”) approved continuous inspection and maintenance program. The Company uses the direct expense method of accounting for its maintenance of regional jet engine overhauls, airframe, landing gear, and normal recurring maintenance wherein the expense is recognized when the maintenance work is completed, or over the period of repair, if materially different. For leased aircraft, the Company is subject to lease return provisions that require a minimum portion of the “life” of an overhaul be remaining on the engine at the lease return date. The Company estimates the cost of maintenance lease return obligations and accrues such costs over the remaining lease term when the expense is probable and can be reasonably estimated.

Engine overhaul expense totaled $13.1 million and $8.4 million for the three months ended June 30, 2018 and 2017, respectively, of which $4.6 million and $0 was pass-through expense and $46.2 million and $53.5 million for the nine months ended June 30, 2018 and 2017, respectively, of which $9.8 million and $0 was pass-through expense. Airframe check expense totaled $6.3 million and $6.7 million for the three months ended June 30, 2018 and 2017, respectively, of which $1.6 million and $2.2 million was pass-through expense and $19.8 million and $16.9 million for the nine months ended June 30, 2018 and 2017, respectively, of which $7.3 million and $2.6 million was pass-through expense.

Pursuant to the United capacity purchase agreement, United reimburses the Company for heavy maintenance on certain E-175 aircraft. Those reimbursements are included in pass-through and other revenue. See Note 1: “Organization and Operations” for further information.

Change in Accounting Policy

Stock Appreciation Rights (“SARs”) and Phantom Stock historically were accounted for as liability compensatory awards under ASC 710, Compensation – General, valued using the intrinsic value method, as permitted by ASC 718 for nonpublic entities. Upon becoming a public company, as defined in ASC 718, in the third quarter of 2018, the Company was required to change its methodology for valuing the SARs and Phantom Stock. While the SARs and Phantom Stock will continue to be re-measured at each quarterly reporting date, the SARs and Phantom Stock are required to be accounted for prospectively at fair value using a fair value pricing model, such as Black-Scholes. The Company recorded the impact of the change in valuation methods as a cumulative effect of a change in accounting principle, as permitted by ASC 250. The effect of the change increased the SARs and Phantom Stock liability by $2.4 million which was the difference in compensation cost measured using the intrinsic value method and the fair value method. An equal and offsetting change to retained earnings in the condensed consolidated balance sheet was recorded with the revaluation. Any future changes in fair value will be recorded as compensation expense in the condensed consolidated statement of operations.

 

3.	Recent Accounting Pronouncements

In May 2014, the FASB issued ASU (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). The standard establishes a new recognition model that requires revenue to be recognized in a manner to depict the transfer of goods or services to a customer at an amount that reflects the consideration expected to be received in exchange for those goods or services. The Company may adopt the requirements of ASU 2014-09 using either of two acceptable methods: (1) retrospective adoption to each prior period presented with the option to elect certain practical expedients; or (2) adoption with the cumulative effect recognized at the date of initial application and providing certain disclosures. In July 2015, the FASB approved a one-year deferral of the effective date of the new standard, making it effective for our reporting periods beginning October 1, 2018. The Company has preliminarily elected to use the modified retrospective method to adopt the new guidance. The Company currently does not anticipate the adoption of ASU No. 2014 09 will have a material impact on its financial position and results of operations.

 

7

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which provides guidance requiring lessees to recognize a right-of-use asset and a lease liability on the balance sheet for substantially all leases, with the exception of short-term leases. Leases will be classified as either financing or operating, with classification affecting the pattern of expense recognition in the statement of income. The guidance is effective for annual periods beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the potential impact of adopting this new guidance on its condensed consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718)—Improvements to Employee Share-Based Payment Accounting, which simplifies several areas of accounting for share-based compensation arrangements, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. ASU 2016-09 requires that the tax impact related to the difference between share-based compensation for book and tax purposes be recognized as income tax benefit or expense in the reporting period in which such awards vest. ASU 2016-09 also required a modified retrospective adoption for previously unrecognized excess tax benefits. The guidance in ASU 2016-09 is effective for public business entities for annual periods beginning after December 15, 2016, including interim periods within those annual reporting periods. The Company adopted ASU 2016-09 in the first quarter of fiscal 2018 on a modified retrospective basis, recognizing all excess tax benefits previously unrecognized, as a cumulative-effect adjustment increasing deferred tax assets by $0.4 million, increasing income tax expense by $0.3 million, and increasing retained earnings by $0.7 million. Adoption of ASU 2016-09 did not have any other material effect on the Company’s results of operations, financial position or cash flows.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force), which clarifies how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The new standard is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the impact of this standard on its condensed consolidated statements of cash flows. Further, in November 2016, the FASB issued ASU No. 2016-18 that requires restricted cash and cash equivalents to be included with cash and cash equivalents on the statement cash flows. The new standard is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. The Company has restricted cash of $3.8 million as of June 30, 2018 and intends to adopt the new guidance in fiscal 2019.

 

4.	Concentrations

At June 30, 2018, the Company had capacity purchase agreements with American and United. All of the Company’s condensed consolidated revenue for the nine months ended June 30, 2018 and 2017 and accounts receivable at the end of each of these periods was derived from these agreements. The terms of both the American and United capacity purchase agreements are not aligned with the lease obligations on the aircraft performing services under such agreements.

Amounts billed by the Company under capacity purchase agreements are subject to the Company’s interpretation of the applicable capacity purchase agreement and are subject to audit by the Company’s major airline partners. Periodically, the Company’s major airline partners dispute amounts billed and pay amounts less than the amount billed. Ultimate collection of the remaining amounts not only depends upon the Company prevailing under the applicable audit, but also upon the financial well-being of the major airline partner. As such, the Company periodically reviews amounts past due and records a reserve for amounts estimated to be uncollectible. The allowance for doubtful accounts was $1.7 million and $0.7 million at June 30, 2018 and September 30, 2017, respectively. If the Company’s ability to collect these receivables and the financial viability of our partners is materially different than estimated, the Company’s estimate of the allowance could be materially impacted.

American accounted for approximately 54% and 55% of the Company’s total revenue for the three months ended June 30, 2018 and 2017, respectively, and 57% for the nine months ended June 30, 2018 and 2017, respectively. United accounted for approximately 46% and 45% of the Company’s revenue for the three months ended June 30, 2018 and 2017, respectively, and 43% for the nine months ended June 30, 2018 and 2017, respectively. A termination of either the American or the United capacity purchase agreement would have a material adverse effect on the Company’s business prospects, financial condition, results of operations, and cash flows.

 

8

5.	Intangible Assets

Information about the intangible assets of the Company at June 30, 2018 and September 30, 2017, were as follows (in thousands):

 

		June 30,				September 30,
		2018				2017
Customer relationship		$	43,800			$	43,800
Accumulated amortization			(32,363	)			(32,076	)
		$	11,437			$	11,724

Total amortization expense recognized was approximately $0.1 million for the three months ended June 30, 2018 and 2017, respectively, and $0.3 million for the nine months ended June 30, 2018 and 2017, respectively. The Company expects to record amortization expense of $0.1 million for the remainder of 2018, and $1.8 million, $1.5 million, $1.2 million, $1.0 million for fiscal years 2019, 2020, 2021, 2022, respectively.

 

6.	Balance Sheet Information

Certain significant amounts included in the company’s condensed consolidated balance sheet as of June 30, 2018 and September 30, 2017, consisted of the following (in thousands):

 

		June 30,				September 30,
		2018				2017
Expendable parts and supplies, net
Expendable parts and supplies		$	18,687			$	17,807
Less obsolescence and warranty reserve			(2,971	)			(2,693	)
		$	15,716			$	15,114
Prepaid expenses and other current assets
Prepaid aircraft rent		$	27,195			$	53,645
Unutilized manufacturer credits			3,000				—
Deferred offering and reimbursed costs			3,992				1,863
Other			5,315				6,017
		$	39,502			$	61,525
Property and equipment—net
Aircraft and other flight equipment substantially pledged		$	1,475,572			$	1,388,990
Other equipment			3,743				3,383
Leasehold improvements			2,746				2,746
Vehicles			692				744
Building			699				699
Furniture and fixtures			287				251
Total property and equipment			1,483,739				1,396,813
Less accumulated depreciation			(244,191	)			(204,365	)
		$	1,239,548			$	1,192,448
Other accrued expenses
Accrued property taxes		$	5,671			$	6,484
Accrued interest			7,181				4,036
Accrued vacation			5,155				2,663
Accrued wheels, brakes and tires			1,406				2,477
Other			9,236				8,269
		$	28,649			$	23,929

Depreciation expense totaled approximately $15.9 million and $47.3 million for the three and nine months ended June 30, 2018, respectively, and approximately $15.5 million and $44.9 million for the three and nine months ended June 30, 2017, respectively.

The Company recorded amortization of the unfavorable lease liability for approximately $1.7 million and $5.1 million for the three and nine months ended June 30, 2018 and 2017, respectively, as a reduction to lease expense. During the three months ended June 30, 2018, the Company wrote off $1.2 million of unfavorable lease liability related to the lease termination of its aircraft lease facility with Wells Fargo Bank Northwest, National Association, as owner trustee and lessor (the “GECAS Lease Facility”), which was accounted for as lease termination expense.

 

 

9

7.	Fair Value Measurements

The carrying values of cash and cash equivalents, unrestricted cash, accounts receivable, and accounts payable included on the accompanying condensed consolidated balance sheets approximated fair value at June 30, 2018 and September 30, 2017.

The Company’s debt agreements are not traded on an active market. The Company has determined the estimated fair value of its debt to be Level 3, as certain inputs used to determine the fair value of these agreements are unobservable and, therefore, could be sensitive to changes in inputs. The Company utilizes the discounted cash flow method to estimate the fair value of Level 3 debt.

The carrying value and estimated fair value of the Company’s long-term debt, including current maturities, were as follows (in millions):

 

		June 30, 2018								September 30, 2017
		Carrying Value				Fair Value				Carrying Value				Fair Value
Long-term debt, including current maturities(1)		$	994.1			$	993.4			$	956.9			$	975.0

 

(1)	Current and prior period long-term debts’ carrying and fair values exclude net debt issuance costs.

 

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8.	Long-Term Debt and Other Borrowings

Long-term debt as of June 30, 2018 and September 30, 2017, consisted of the following (in thousands):

 

		June 30,				September 30,
		2018				2017
Notes payable to financial institution, collateralized by the underlying aircraft, due 2019(1)(2)		$	7,049			$	58,254
Notes payable to financial institution, collateralized by the underlying aircraft, due 2022(3)(4)			72,839				113,611
Notes payable to financial institution, collateralized by the underlying aircraft, due 2024(5)			74,822				82,776
Senior and subordinated notes payable to secured parties, collateralized by the underlying aircraft, due 2027(6)			125,460				137,028
Notes payable to secured parties, collateralized by the underlying aircraft, due 2028(7)			217,930				226,399
Senior and subordinated notes payable to secured parties, collateralized by the underlying aircraft, due 2028(8)			170,777				181,115
Senior and subordinated notes payable to secured parties, collateralized by the underlying aircraft, due 2022(17)			97,069				—
Notes payable to financial institution, collateralized by the underlying equipment, due 2022(9)			89,807				93,031
Senior and subordinated notes payable to secured parties, collateralized by the underlying aircraft, due 2022(10)			67,282				—
Notes payable to financial institution, collateralized by the underlying equipment, due 2020(11)			3,732				4,976
Notes payable to financial institution due 2020(12)			4,867				6,390
Notes payable to financial institution, collateralized by the underlying equipment, due 2020(13)			17,749				9,158
Notes payable to financial institution due 2019(14)			9,055				18,530
Working capital draw loan, collateralized by certain flight equipment and spare parts(15)			25,650				25,650
Other obligations due to financial institution, collateralized by the underlying equipment, due 2023(16)			10,014				—
Total long-term debt			994,102				956,918
Less current portion			(149,936	)			(140,466	)
Less unamortized debt issuance costs			(15,679	)			(12,578	)
Long-term debt—excluding current portion		$	828,487			$	803,874

 

(1)	In fiscal 2005, the Company financed five CRJ-900 aircraft with $118 million in debt. The debt bears interest at the monthly London InterBank Offered Rate (“LIBOR”), plus 3% (5.092% at June 30, 2018) and requires monthly principal and interest payments.

(2)	In fiscal 2004, the Company financed five CRJ-700 and nine CRJ 900 aircraft with $254.7 million in debt. The debt bears interest at the monthly LIBOR plus 3% (5.092% at June 30, 2018) and requires monthly principal and interest payments.

(3)	In fiscal 2007, the Company financed three CRJ-900 and three CRJ-700 aircraft for $120.3 million. The debt bears interest at the monthly LIBOR plus 2.25% (4.342% at June 30, 2018) and requires monthly principal and interest payments.

(4)	In fiscal 2014, the Company financed 10 CRJ-900 aircraft for $88.4 million. The debt bears interest at the monthly LIBOR plus a spread ranging from 1.95% to 7.25% (4.042% to 9.342% at June 30, 2018) and requires monthly principal and interest payments.

(5)	In fiscal 2014, the Company financed eight CRJ-900 aircraft with $114.5 million in debt. The debt bears interest at 5% and requires monthly principal and interest payments.

(6)

In fiscal 2015, the Company financed seven CRJ-900 aircraft with $170.2 million in debt. The senior notes payable of $151 million bear interest at monthly LIBOR plus 2.71% (4.802% at June 30, 2018) and require monthly principal and interest payments. The subordinated notes payable are noninterest-bearing and become payable in full on the last day of the term of the notes. The Company has imputed an interest rate of 6.25% on the subordinated notes payable and recorded a related discount of $8.1 million, which is being accreted to interest expense over the term of the notes.

(7)	In fiscal 2016, the Company financed 10 E-175 aircraft with $246 million in debt under an EETC financing arrangement (see discussion below). The debt bears interest ranging from 4.75% to 6.25% and requires semi-annual principal and interest payments.

(8)

In fiscal 2016, the Company financed eight E-175 aircraft with $195.3 million in debt. The senior notes payable of $172 million bear interest at the three-month LIBOR plus a spread ranging from 2.20% to 2.32% (4.537% to 4.657% at June 30, 2018) and require quarterly principal and interest payments. The subordinated notes payable bear interest at 4.50% and require quarterly principal and interest payments.

 

11

(9)	In fiscal 2017, the Company financed certain flight equipment with $99.1 million in debt. The debt bears interest at the monthly LIBOR (rounded to the nearest 16th) plus 7.25% (9.342% at June 30, 2018) and requires monthly principal and interest payments.

(10)

In December 2017, the Company refinanced nine CRJ-900 aircraft with $74.9 million in debt. The senior notes payable of $46.9 million bear interest at the monthly LIBOR plus 3.50% (5.592% at June 30, 2018) and require quarterly principal and interest payments. The subordinated notes payable bear interest at the monthly LIBOR plus 4.50% (6.592% at June 30, 2018) and require quarterly principal and interest payments.

(11)	In fiscal 2015, the Company financed certain flight equipment with $8.3 million in debt. The debt bears interest at 5.163% and requires monthly principal and interest payments.

(12)	In fiscal 2015 and 2016, the Company financed certain flight equipment maintenance costs with $10.2 million in debt. The debt bears interest at the monthly LIBOR plus 3.07% (5.162% at June 30, 2018) and requires quarterly principal and interest payments.

(13)

In fiscal 2016 and 2017, the Company financed certain flight equipment maintenance costs with $11.9 million in debt. The debt bears interest at the three-month LIBOR plus a spread ranging from 2.93% to 2.96% (5.267% to 5.297% at June 30, 2018) and requires quarterly principal and interest payments. The debt is subject to a fixed charge ratio covenant. As of June 30, 2018, the Company was in compliance with this covenant.

(14)

In fiscal 2017, the Company financed certain flight equipment maintenance costs with $25 million in debt. The debt bears interest at the three-month LIBOR plus 3.30% (5.637% at June 30, 2018) and requires quarterly principal and interest payments. The debt is subject to a fixed charge ratio covenant. As of June 30, 2018, the Company was in compliance with this covenant.

(15)

In fiscal 2016, the Company obtained a $35 million working capital draw loan, which terminates in August 2019. Interest is assessed on drawn amounts at one-month LIBOR plus 4.25% (6.342% at June 30, 2018). The line was drawn upon during fiscal 2017. The working capital draw loan is subject to an interest and rental coverage ratio covenant. As of June 30, 2018, the Company was in compliance with this covenant.

(16)	In February 2018, the Company leased two spare engines. The leases were determined to be capital as the leases contain a bargain purchase option at the end of the term. Imputed interest is 9.13% and the leases requires monthly payments.

(17)

In June 2018, the Company refinanced six CRJ-900 aircraft with $27.5 million in debt and financed nine CRJ-900 aircraft, which were previously lease, with $69.6 million in debt. The senior notes payable of $67.3 million bear interest at the three-month LIBOR plus 3.50% (5.837% at June 30, 2018) and require quarterly principal and interest payments. The subordinated notes payable bear interest at the three month LIBOR plus 7.50% (9.837% at June 30, 2018) and require quarterly principal and interest payments.

Principal maturities of long-term debt as of June 30, 2018, and for each of the next five years are as follows (in thousands):

 

Periods Ending September 30,		Total Principal Amount
Remainder of 2018			40,260
2019			176,519
2020			152,316
2021			146,218
2022			141,917

The net book value of collateralized aircraft and equipment as of June 30, 2018 was $1,170.4 million.

In December 2015, an Enhanced Equipment Trust Certificate (“EETC”) pass-through trust was created to issue pass-through certificates to obtain financing for new E-175 aircraft. At June 30, 2018 Mesa has $217.9 million of equipment notes outstanding issued under the EETC financing included in long-term debt on the condensed consolidated balance sheets. The structure of the EETC financing consists of a pass-through trust created by Mesa to issue pass-through certificates, which represent fractional undivided interests in the pass-through trust and are not obligations of Mesa.

The proceeds of the issuance of the pass-through certificates were used to purchase equipment notes which were issued by Mesa and secured by its aircraft. The payment obligations under the equipment notes are those of Mesa. Proceeds received from the sale of pass-through certificates were initially held by a depositary in escrow for the benefit of the certificate holders until Mesa issued equipment notes to the trust, which purchased such notes with a portion of the escrowed funds.

Mesa evaluated whether the pass-through trust formed for its EETC financing is a Variable Interest Entity (“VIE”) and required to be consolidated. The pass-through trust was determined to be a VIE, however, the Company has determined that it does not have a variable interest in the pass-through trust, and therefore, has not consolidated the pass-through trust with its financial statements.

On June 27, 2018, the Company refinanced $16.0 million of debt on six CRJ-900 aircraft (due in 2019), with $27.5 million of debt, resulting in net cash proceeds to the Company of $10.4 million after transaction related fees. The notes payable require quarterly payments of principal and interest through fiscal 2022 bearing interest at LIBOR plus 3.50%.

 

12

On June 28, 2018, the Company purchased nine CRJ-900 aircraft, which were previously leased under the GECAS Lease Facility, for $76.5 million. The Company financed the aircraft purchase with $69.6 million in new debt and proceeds from the June 2018 aircraft refinancing. The notes payable of $69.6 million require quarterly payments of principal and interest through fiscal 2022 bearing interest at LIBOR plus a spread ranging from 3.50% for the senior promissory notes to 7.50% for the subordinated promissory notes. The Company recorded non-cash lease termination expense of $15.1 million in connection with the lease buyout. Also, as part of the transaction, the Company (i) received $4.5 million of future goods and services credits and $5.6 million of loan forgiveness for loans with a maturity date in 2027 from the aircraft manufacturer, and (ii) mutually agreed with GE Capital Aviation Services LLC to terminate the GE Warrant.

 

9.	Earnings Per Share and Equity

Calculations of net income per common share attributable to Mesa Air Group were as follows (in thousands, except per share data):

 

		Three Months Ended June 30,								Nine Months Ended June 30,
		2018				2017				2018				2017
Net income attributable to Mesa Air Group		$	(11,135	)		$	15,433			$	13,861			$	27,347
Basic weighted average common shares outstanding			12,462				10,993				11,782				10,852
Add: Incremental shares for:(1)
Dilutive effect of warrants			—				12,230				11,702				12,389
Dilutive effect of restricted stock			—				—				568				—
Diluted weighted average common shares outstanding			12,462				23,223				24,052				23,241
Net income per common share attributable to Mesa Air Group:
Basic		$	(0.89	)		$	1.40			$	1.18			$	2.52
Diluted		$	(0.89	)		$	0.66			$	0.58			$	1.18

 

(1)	Due to a loss for the three months ended June 30, 2018, zero incremental shares are included because the effect would be antidilutive.

Basic income per common share is computed by dividing net income attributable to Mesa Air Group by the weighted average number of common shares outstanding during the period.

The number of incremental shares from the assumed issuance of shares relating to restricted stock and exercise of warrants is calculated by applying the treasury stock method. Share-based awards and warrants whose impact is considered to be anti-dilutive under the treasury stock method were excluded from the diluted net income or loss per share calculation. In loss periods, these incremental shares are excluded from the calculation of diluted loss per share, as the inclusion of unvested restricted stock and warrants would have an anti-dilutive effect. Anti-dilutive shares relating to restricted stock and exercise of warrants of 523,343 and 11,056,295, respectively, were excluded from the calculation of diluted loss per share for the three months ended June 30, 2018.

 

10.	Common Stock

The Company previously issued warrants to third parties, which had a five-year term to be converted to common stock at an exercise price of $0.004 per share. Outstanding warrants to purchase shares of common stock are held by persons who are not U.S. citizens. The warrants are not exercisable due to restrictions imposed by federal law requiring that no more than 24.9% of our stock be voted, directly or indirectly, or controlled by persons who are not U.S. citizens. The warrants can be converted to common stock upon warrant holders demonstrating U.S. citizenship. During June 2018, the Company extended the term of outstanding warrants set to expire by five years (through fiscal year 2023). Any warrants that were not extended were forfeited.

On June 28, 2018, the Company agreed with GE Capital Aviation Services LLC (“GE Capital”) to terminate a warrant to purchase 250,000 shares of common stock held by GE Capital. Our shares of common stock are listed on the NASDAQ Global Market under the symbol “MESA” effective August 10, 2018.

 

13

11.	Income Taxes

The Company’s effective tax rate (ETR) from continuing operations was 23.9% and 228.2% for the three and nine months ended June 30, 2018 and 37.0% and 37.2% for the three and nine months ended June 30, 2017, respectively. The quarterly and year-to-date ETR was significantly different from our historical ETR as a result of the comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) enacted by the U.S. government on December 22, 2017, the adoption of ASU 2016-09, state taxes, changes in the valuation allowance against state net operating losses, expired state attributes and the benefit from changes in state apportionment and statutory rates.

The Tax Act makes broad and complex changes to the U.S. tax code that will affect the Company’s fiscal year ending September 30, 2018, including but not limited to (1) reducing the U.S. federal corporate tax rate, (2) changing rules related to uses and limitations of NOL carryforwards created in tax years beginning after December 31, 2017, (3) eliminating the corporate alternative minimum tax (“AMT”) and changing how existing AMT credits can be realized, and (4) bonus depreciation that will allow for full expensing of qualified property. The Tax Act reduces the federal corporate tax rate to 21% in the fiscal year ending September 30, 2018. The Internal Revenue Code stipulates that the Company’s fiscal year ending September 30, 2018, will have a blended corporate tax rate of 24.53%, which is based on the applicable tax rates before and after the Tax Act and the number of days in the year.

The SEC staff issued SAB 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.

In connection with our initial analysis of the impact of the Tax Act, we have recorded a discrete net tax benefit of $21.4 million in the nine months ending June 30, 2018. As discussed more fully below, the Company has not completed its accounting for the income tax effects of certain elements of the Tax Act. The Company has recorded provisional adjustments where reasonable adjustments are available. Where reasonable adjustments are not available, the Company has not recorded and provisions adjustments and continues to account for them in accordance with ASC 740.

Our accounting for the following elements of the Tax Act is complete:

Reduction of U.S. federal corporate tax rate: The Act reduces the corporate tax rate to 21 percent, effective January 1, 2018. Consequently, we have recorded a decrease related to our net deferred tax liabilities of $21.4 million, with a corresponding net adjustment to deferred income tax benefit of $21.4 million for the nine months ended June 30, 2018.

The Company was not able to make reasonable estimates or, correspondingly, record provisional adjustments for the following:

Valuation allowances: The Company must determine whether the valuation allowance assessments are affected by various aspects of the Tax Act (e.g. section 163(j), state effect of The Act, net operating loss carryforwards). Any corresponding determinations relating to changes in valuation allowances have, likewise, not been completed or recorded.

As of September 30, 2017, we had aggregate federal and state net operating loss carryforwards of approximately $299.8 million and $172.3 million, which expire in 2027-2036 and 2018-2037, respectively, with approximately $20.1 million of state net operating loss carryforwards expiring in 2018. The net operating loss carryforward increased by an estimated $111.4 million as of June 30, 2018 resulting in a total net operating loss carryforward of $411.2 million.

 

14

12.	Share-Based Compensation

Restricted Stock

The restricted stock activity for the nine months ended June 30, 2018 were summarized as follows:

 

						Weighted-
						Average
		Number				Grant Date
		of Shares				Fair Value
Restricted shares unvested at September 30, 2017			775,753			$	5.22
Granted			—				—
Vested			(199,305	)			4.54
Forfeited			—				—
Restricted shares unvested at June 30, 2018			576,448			$	5.45

Stock Appreciation Rights

The SARs activity for the nine months ended June 30, 2018 were summarized as follows:

 

						Weighted-
						Average
		Number				Grant Date
		of Shares				Fair Value
SARs unvested at September 30, 2017			1,140,013			$	—
Granted			—				—
Vested			(622,238	)			—
Forfeited			—				—
SARs unvested at June 30, 2018			517,775			$	7.58

Phantom Stock

On October 17, 2017, the Company implemented a share-based payment plan under which employees, officers, directors and other individuals providing services to the Company are eligible to receive grants of restricted phantom stock units (“Phantom Stock Plan”). The restricted phantom stock units (“restricted stock units” or “RSUs”) provide a participant with the right to receive a cash or stock bonus based on the fair market value of a stated number of RSUs that are vested. The shares of Common Stock that may be subject to RSUs granted under the Plan shall not exceed an aggregate of 1,250,000 shares. All of the RSUs are non-vested and forfeitable as of the grant date and vest over a three-year period. Any vested RSU will be settled by the Company upon vesting but no later than March 15 of the calendar year after the date that the RSUs become vested. The Company has elected to use the fair value method to account for its share-based payment awards that are payable in cash, and therefore classified as liability awards, see Note 2: “Summary of Significant Accounting Policies” for effects due to a change in accounting method. Under the fair value method, the compensation expense associated with these awards is measured by estimated fair value of the Company’s common stock on the valuation date and is recognized ratably over the vesting period. Upon the settlement of a RSU, compensation cost is adjusted to the amount of the cash or stock payment. The Company estimates the fair value of its common stock based on recent share transactions. The Company has authorized 1,250,000 shares available under this plan and has granted 536,538 since inception of the plan. Since inception of the plan, 44,623 RSUs have vested or settled.

 

15

The phantom stock activity for the nine months ended June 30, 2018 were summarized as follows:

 

						Weighted-
						Average
		Number				Grant Date
		of Shares				Fair Value
Phantom stock unvested at September 30, 2017			—			$	—
Granted			536,538				6.08
Vested			(44,623	)			7.50
Forfeited			—				—
Phantom stock unvested at June 30, 2018			491,915			$	13.55

As of June 30, 2018, there was $11.4 million, of total unrecognized compensation cost related to unvested share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 1.6 years.

Compensation cost for share-based awards are recognized on a straight-line basis over the vesting period. Share-based compensation expense for the three months ended June 30, 2018 and 2017 was $11.6 million and $0, respectively, and for the nine months ended June 30, 2018 and 2017 was $12.6 million and $1.7 million, respectively. Share-based compensation expenses are recorded in general and administrative expenses in the condensed consolidated statements of operations.

Following the IPO there will be no further grants under the Stock Appreciation Rights and Phantom Stock plans. Immediately following the IPO, shares of restricted common stock were issued to certain of its employees and directors under its 2018 Plan in exchange for the cancellation of existing restricted phantom stock units, unvested restricted shares and SARs (see note 15—Subsequent Events).

 

13.	Commitments

At June 30, 2018, the Company leased 28 aircraft under noncancelable operating leases with remaining terms of up to 5.75 years. The Company has the option to terminate certain leases at various times throughout the lease. The Company headquarters and other facility noncancelable operating leases have remaining terms of up to nine years. The leases require the Company to pay all taxes, maintenance, insurance, and other operating expenses. Rental expense is recognized on a straight-line basis over the lease term, net of lessor rebates and other incentives. Aggregate rental expense under all operating aircraft, equipment and facility leases totaled approximately $21.6 million and $21.0 million for the three months ended June 30, 2018 and 2017, respectively, and $62.8 million and $62.3 million for the nine months ended June 30, 2018 and 2017, respectively.

Future minimum lease payments as of June 30, 2018, under noncancelable operating leases are as follows (in thousands):

 

Periods Ending September 30,		Aircraft				Other				Total
Remainder of 2018		$	18,146			$	730			$	18,876
2019			63,449				2,007				65,456
2020			45,534				1,580				47,114
2021			44,314				1,367				45,681
2022			29,751				1,339				31,090
Thereafter			24,267				4,013				28,280
Total		$	225,461			$	11,036			$	236,497

The majority of the Company’s leased aircraft are leased through trusts that have a sole purpose to purchase, finance, and lease these aircraft to the Company; therefore, they meet the criteria of a variable interest entity. However, since these are single-owner trusts in which the Company does not participate, the Company is not at risk for losses and is not considered the primary beneficiary. Management believes that the Company’s maximum exposure under these leases is the remaining lease payments.

 

16

14.	Contingencies

The Company is involved in various legal proceedings (including, but not limited to, insured claims) and FAA civil action proceedings that the Company does not believe will have a material adverse effect upon its business, financial condition, or results of operations, although no assurance can be given to the ultimate outcome of any such proceedings.

 

15.	Subsequent Events

On August 8, 2018, the Company filed its Second Amended and Restated Articles of Incorporation, which, among other things: (i) effected a 2.5-for-1 stock split of its common stock; and (ii) increased the authorized number of shares of its common and preferred stock to 125,000,000 and 5,000,000, respectively. All references to share and per share amounts in the Company’s condensed consolidated financial statements have been retrospectively revised to reflect the stock split and increase in authorized shares.

On August 14, 2018, the Company completed the IPO and issued and sold 9,630,000 shares of common stock at a public offering price of $12.00 per share, resulting in gross proceeds to the Company of approximately $115.6 million.

In July 2018, the Company’s Board of Directors and Compensation Committee approved the issuance of shares of restricted common stock under its 2018 Plan immediately following the IPO to certain of its employees and directors in exchange for the cancellation of existing restricted phantom stock units, unvested restricted shares and SARs. The shares of restricted common stock issued under the 2018 Plan in exchange for the cancellation of restricted phantom stock units, unvested restricted shares and SARs are subject to vesting on the same terms set forth in the prior vesting schedules and are not subject to acceleration in connection with the 2018 Plan issuances.

On August 14, 2018 the Company paid down the outstanding balance on the CIT Revolving Credit Facility of $25.7 million.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read together with our condensed financial statements and related notes and other financial information included elsewhere in this Quarterly Report on Form 10-Q and our financial statements and the related notes and other financial information included in our final prospectus filed with the Securities and Exchange Commission pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended (the “Securities Act”), on August 10, 2018. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Quarterly Report on Form 10-Q, particularly in the section titled “Risk Factors.”

Overview

Mesa Airlines is a regional air carrier providing scheduled passenger service to 115 cities in 38 states, the District of Columbia, Canada, Mexico, and the Bahamas. All of our flights are operated as either American Eagle or United Express flights pursuant to the terms of capacity purchase agreements we entered into with American Airlines, Inc. (“American”) and United Airlines, Inc. (“United”) (each, our “major airline partner”). We have a significant presence in several of our major airline partners’ key domestic hubs and focus cities, including Dallas, Houston, Phoenix and Washington-Dulles.

As of June 30, 2018, we operated a fleet of 145 aircraft with approximately 600 daily departures. We operate 64 CRJ-900 aircraft under our capacity purchase agreement with American (our “American Capacity Purchase Agreement”) and 20 CRJ-700 and 60 E-175 aircraft under our capacity purchase agreement with United (our “United Capacity Purchase Agreement”). For the nine months ended June 30, 2018, approximately 55% of our aircraft in scheduled service were operated for United and approximately 45% were operated for American. All of our operating revenue in our 2017 fiscal year and the nine months ended June 30, 2018 was derived from operations associated with our American and United Capacity Purchase Agreements.

Our long-term capacity purchase agreements provide us guaranteed monthly revenue for each aircraft under contract, a fixed fee for each block hour and flight actually flown, and reimbursement of certain direct operating expenses in exchange for providing regional flying on behalf of our major airline partners. Our capacity purchase agreements also shelter us from many of the elements that cause volatility in airline financial performance, including fuel prices, variations in ticket prices, and fluctuations in number of passengers. In providing regional flying under our capacity purchase agreements, we use the logos, service marks, flight crew uniforms and aircraft paint schemes of our major airline partners. Our major airline partners control route selection, pricing, seat inventories, marketing and scheduling, and provide us with ground support services, airport landing slots and gate access.

Components of Results of Operations

The following discussion summarizes the key components of our condensed consolidated statements of operations.

Operating Revenues

Our condensed consolidated operating revenues consist primarily of contract revenue flight services as well as pass-through and other revenues.

Contract Revenue. Contract revenue consists of the fixed monthly amounts per aircraft received pursuant to our capacity purchase agreements with our major airline partners, along with the additional amounts received based on the number of flights and block hours flown. Contract revenues we receive from our major airline partners are paid and recognized by us on a weekly basis.

Pass-Through and Other. Pass-through and other revenue consists of passenger and hull insurance, aircraft property taxes, landing fees, catering and certain maintenance costs related to our E-175 aircraft that we equally recognize as both a revenue and expense.

Operating Expenses

Our operating expenses consist of the following items:

Flight Operations. Flight operations expense includes costs related to salaries, bonuses and benefits earned by our pilots, flight attendants, and dispatch personnel, as well as costs related to technical publications, lodging of our flight crews and pilot training expenses.

 

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Fuel. Fuel expense includes fuel and related fueling costs for flying we undertake outside of our capacity purchase agreements, including aircraft repositioning and maintenance. As of June 30, 2018, all aircraft fuel and related fueling costs for flying under our capacity purchase agreements were directly paid and supplied by our major airline partners. Accordingly, we do not record an expense or the related revenue for fuel supplied by American and United for flying under our capacity purchase agreements.

Maintenance. Maintenance includes costs related to engine overhauls, airframe, landing gear and normal recurring maintenance, which includes pass-through maintenance costs related to our E-175 aircraft, as well as maintenance lease return obligations on our leased aircraft when the expense is probable and can be reasonably estimated. We record these expenses using the direct expense method of accounting, wherein the expense is recognized when the maintenance work is completed, or over the repair period, if materially different. As a result of using the direct expense method, the timing of maintenance expense reflected in the financial statements may vary significantly period to period.

Aircraft Rent. Aircraft rent includes costs related to leased engines and aircraft.

Aircraft and Traffic Servicing. Aircraft and traffic servicing includes expenses related to our capacity purchase agreements, including aircraft cleaning, passenger disruption reimbursements, international navigation fees and wages of airport operations personnel, a portion of which are reimbursable by our major airline partners.

General and Administrative. General and administrative expense includes insurance and taxes, non-operational administrative employee wages and related expenses, building rents, real property leases, utilities, legal, audit and other administrative expenses.

Depreciation and Amortization. Depreciation expense is a periodic non-cash charge primarily related to aircraft, engine and equipment depreciation. Amortization expense is a periodic non-cash charge related to our customer relationship intangible asset.

Other (Expense) Income, Net

Interest Expense. Interest expense is interest on our debt to finance purchases of aircraft, engines, equipment as well as debt financing costs amortization.

Interest Income. Interest income includes interest income on our cash and cash equivalent balances.

Other Expense. Other expense includes expense derived from activities not classified in any other area of the condensed consolidated statements of income, including write-offs of miscellaneous third-party fees.

Segment Reporting

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing operating performance. In consideration of Accounting Standards Codification (“ASC”) 280, “Segment Reporting,” we are not organized around specific services or geographic regions. We currently operate in one service line providing scheduled passenger services in accordance with our capacity purchase agreements.

While we operate under two separate capacity purchase agreements, we do not manage our business based on any performance measure at the individual contract level. Additionally, our chief operating decision maker uses consolidated financial information to evaluate our performance, which is the same basis on which he communicates our results and performance to our Board of Directors. He bases all significant decisions regarding the allocation of our resources on a consolidated basis. Based on the information described above and in accordance with the applicable literature, management has concluded that we are organized and operated as one operating and reportable segment.

Cautionary Statement Regarding Non-GAAP Measures

We present Adjusted EBITDA and Adjusted EBITDAR in this Quarterly Report on Form 10-Q, which are not recognized financial measures under accounting principles generally accepted in the United States of America (“GAAP”), as supplemental disclosures because our senior management believes that they are well recognized valuation metrics in the airline industry that are frequently used by companies, investors, securities analysts and other interested parties in comparing companies in our industry.

 

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Adjusted EBITDA. We define Adjusted EBITDA as net income or loss before interest, income taxes, depreciation and amortization, adjusted for the impact of revaluation of liability awards and lease termination costs.

Adjusted EBITDAR. We define Adjusted EBITDAR as net income or loss before interest, income taxes, depreciation and amortization and aircraft rent, adjusted for the impact of revaluation of liability awards and lease termination costs.

You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. In evaluating Adjusted EBITDA and Adjusted EBITDAR, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in our presentation of Adjusted EBITDA and Adjusted EBITDAR. Our presentation of Adjusted EBITDA and Adjusted EBITDAR should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. There can be no assurance that we will not modify the presentation of Adjusted EBITDA or Adjusted EBITDAR and any such modification may be material.

Adjusted EBITDA and Adjusted EBITDAR have limitations as analytical tools. Some of the limitations applicable to these measures include: (i) Adjusted EBITDA and Adjusted EBITDAR do not reflect the impact of certain cash charges resulting from matters we consider not to be indicative of our ongoing operations; (ii) Adjusted EBITDA and Adjusted EBITDAR do not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments; (iii) Adjusted EBITDA and Adjusted EBITDAR do not reflect changes in, or cash requirements for, our working capital needs; (iv) Adjusted EBITDA and Adjusted EBITDAR do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debts; (v) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future; and (vi) Adjusted EBITDA and Adjusted EBITDAR do not reflect any cash requirements for such replacements and other companies in our industry may calculate Adjusted EBITDA and Adjusted EBITDAR differently than we do, limiting its usefulness as a comparative measure. Because of these limitations, Adjusted EBITDA and Adjusted EBITDAR should not be considered in isolation or as a substitute for performance measures calculated in accordance with GAAP. In addition, Adjusted EBITDAR should not be viewed as a measure of overall performance because it excludes aircraft rent, which is a normal, recurring cash operating expense that is necessary to operate our business. For the foregoing reasons, each of Adjusted EBITDA and Adjusted EBITDAR has significant limitations which affect its use as an indicator of our profitability. Accordingly, you are cautioned not to place undue reliance on this information.

Results of Operations

Three Months Ended June 30, 2018 Compared to Three Months Ended June 30, 2017

We had an operating loss of $0.5 million in our three months ended June 30, 2018 compared to operating income of $36.4 million in our three months ended June 30, 2017. Our operating results for the three months ended June 30, 2018 reflected an increase in contract revenue primarily related to the addition of 10 E-175 aircraft under our United Capacity Purchase Agreement, which was partially offset by reduced flying in our CRJ fleet. We also experienced an increase in flight operations expense driven by an increase in pilot training and related expenses and an increase in premium pilot pay to incentivize pilots to fly additional routes until additional pilots complete their training.

Our maintenance expense increased due to the timing of significant pass through maintenance events, including engine overhauls, which occurred more frequently during the three months ended June 30, 2018 than during the three months ended June 30, 2017.

We recorded two one-time non-cash adjustments in the three months ended June 30, 2018. The first was $15.1 million of lease termination expense related to our acquisition of nine CRJ-900 aircraft, which were previously leased under our GECAS Lease Facility. The second transaction related to an increase in the value of our stock appreciation rights (“SARS”) associated with an increase in fair value of our common stock as well as a change in accounting methodology from the intrinsic value method to fair value method. These changes resulted in a general and administrative expense of $11.1 million.

In our three months ended June 30, 2018, we had a net loss of $11.1 million compared to net income of $15.4 million in our three months ended June 30, 2017. Our three months ended June 30, 2018 results reflected a decrease in net income of $26.5 million primarily related to lease termination expense, an increase in general and administrative expense due to changes in the value of our SARs and an increase in flight operations expense driven by an increase in pilot training expense and premium pilot pay.

 

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Operating Revenues

 

		Three Months Ended June 30,
		2018				2017				Change
Operating revenues ($ in thousands):
Contract		$	159,916			$	157,410			$	2,506				1.6	%
Pass-through and other			11,823				9,542				2,281				23.9	%
Total operating revenues		$	171,739			$	166,952			$	4,787				2.9	%
Operating data:
Available seat miles—ASMs (thousands)			2,440,278				2,384,960				55,318				2.3	%
Block hours			102,939				100,671				2,268				2.3	%
Revenue passenger miles—RPMs (thousands)			1,962,630				1,875,934				86,696				4.6	%
Average stage length (miles)			555				550				5				0.9	%
Contract revenue per available seat mile—CRASM (in cents)		¢	6.55			¢	6.60			¢	(0.05	)			-0.8	%
Passengers			3,490,710				3,364,121				126,589				3.8	%

 

“Available seat miles” or “ASMs” means the number of seats available for passengers multiplied by the number of miles the seats are flown.

“Average stage length” means the average number of statute miles flown per flight segment.

“CRASM” means contract revenue divided by ASMs.

“RPM” means the number of miles traveled by paying passengers

Total operating revenue increased by $4.8 million, or 2.9%, during our three months ended June 30, 2018 as compared to our three months ended June 30, 2017. Contract revenue increased by $2.5 million, or 1.6%, primarily due to an increase in flying with our expanded E-175 fleet and a decrease in credits given to our major airline partners based on contractual utilization levels, partially offset by reduced flying in our CRJ fleet. Our block hours flown during our three months ended June 30, 2018 increased 2.3% compared to the three months ended June 30, 2017 due to increased flying on our E175 fleet partially offset by reduced flight schedules caused by increased pilot training times. Our pass-through and other revenue increased during our three months ended June 30, 2018 by $2.3 million, or 23.9%, primarily due to pass-through maintenance costs related to our E-175 fleet.

Operating Expenses

 

		Three Months Ended June 30,
		2018				2017				Change
Operating expenses ($ in thousands):
Flight operations		$	51,795			$	37,953			$	13,842				36.5	%
Fuel			151				214				(63	)			-29.4	%
Maintenance			48,290				46,817				1,473				3.1	%
Aircraft rent			17,975				18,274				(299	)			-1.6	%
Aircraft and traffic servicing			848				1,178				(330	)			-28.0	%
General and administrative			22,066				10,534				11,532				109.5	%
Depreciation and amortization			16,013				15,620				393				2.5	%
Lease Termination			15,109				—				15,109				100.0	%
Total operating expenses		$	172,247			$	130,590			$	41,657				31.9	%
Operating data:
Available seat miles—ASMs (thousands)			2,440,278				2,384,960				55,318				2.3	%
Block hours			102,939				100,671				2,268				2.3	%
Average stage length (miles)			555				550				5				0.9	%
Departures			57,782				57,054				728				1.3	%

 

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Flight Operations. Flight operations expense increased $13.8 million, or 36.5%, to $51.8 million for our three months ended June 30, 2018 compared to the prior year period. The increase was primarily driven by an increase in pilot training related expenses, an increase in premium pilot pay to incentivize pilots to fly additional routes until additional pilots complete their training and additional pilot and flight attendant wages due to the additional flying as well as our new collective bargaining agreements.

Fuel. Fuel expense decreased $0.06 million, or 29.4%, to $0.2 million for our three months ended June 30, 2018 compared to the same period in 2017. The decrease was primarily driven by a smaller number of ferry flights and maintenance fuel in our Phoenix hub. All fuel costs related to flying under our capacity purchase agreements during our three months ended June 30, 2018 and 2017 were directly paid to suppliers by our major airline partners.

Maintenance. Aircraft maintenance costs increased $1.5 million, or 3.1%, to $48.3 million for our three months ended June 30, 2018 compared to the same period in 2017. This increase was primarily driven by an increase in pass through engine overhaul expense and component contract expense partially offset by a decrease in Labor and other expense. During our three months ended June 30, 2018, $4.6 million of engine overhaul expenses were reimbursable by our major airline partners. Total pass-through maintenance expenses reimbursed by our major airline partners increased by $3.8 million during our three months ended June 30, 2018.

The following table presents information regarding our maintenance costs during our three months ended June 30, 2018 and 2017 (in thousands):

 

		Three Months Ended June 30,
		2018				2017				Change
Engine overhaul		$	8,495			$	8,436			$	59				0.7	%
Pass-through engine overhaul			4,579				—				4,579				100.0	%
C-check			4,686				4,542				144				3.2	%
Pass-through C-check			1,622				2,155				(533	)			-24.7	%
Component contracts			8,980				7,412				1,568				21.2	%
Rotable and expendable parts			5,636				6,248				(612	)			-9.8	%
Other pass-through			2,015				2,267				(252	)			-11.1	%
Labor and other			12,277				15,757				(3,480	)			-22.1	%
Total		$	48,290			$	46,817			$	1,473				3.1	%

Aircraft Rent. Aircraft rent expense decreased $0.3 million, or 1.6%, to $18.0 million from for our three months ended June 30, 2018 compared to the same period in 2017. The decrease is attributable to a $0.1 million decrease in engine rent and a $0.2 million decrease in aircraft lease expense.

Aircraft and Traffic Servicing. Aircraft and traffic servicing expense decreased $0.3 million, or 28.0%, to $0.8 million for our three months ended June 30, 2018 compared to the same period in 2017. The decrease is primarily due to a decrease in pass-through regulatory charges and lower interrupted trip expense and partially offset by higher aircraft cleaning expense. For our three months ended June 30, 2018 and 2017, 52.0% and 56.1%, respectively, of our aircraft and traffic servicing expenses were reimbursed by our major airline partners.

General and Administrative. General and administrative expense increased $11.5 million, or 109.5%, to $22.1 million for our three months ended June 30, 2018 compared to the same period in 2017. The increase is primarily related to a one-time, non-cash $11.1 million expense related to an increase in the value of our stock appreciation rights (“SARS”) associated with an increase in fair value of our common stock.

Depreciation and Amortization. Depreciation and amortization expense increased $0.4 million, or 2.5%, to $16.0 million for our three months ended June 30, 2018 compared to the same period in 2017. The increase is primarily attributable to an increase in depreciation expense related to our purchase of spare engines.

Lease Termination. Lease termination expense increased $15.1 million, or 100.0%, for our three months ended June 30, 2018 compared to the same period in 2017. The increase was related to our acquisition of nine CRJ-900 aircraft which were previously leased under our GECAS Lease Facility.

 

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Other Expense

Other expense increased $2.3 million, or 19.0%, to $14.1 million for our three months ended June 30, 2018, compared to the same period in 2017. The increase is primarily due to an increase in interest expense of $2.0 million related to the financing of 23 spare engines, financing of nine CRJ-900 which were previously leased under the GECAS Lease Facility, refinancing of fifteen CRJ-900 aircraft, our line of credit with CIT, a deferment of certain payments under our aircraft lease facility (the “RASPRO Lease Facility”) with RASPRO Trust 2005, a pass-through trust (“RASPRO”), engine overhaul financing and higher LIBOR rates. Our expenses related to debt financing amortization were also higher by $0.3 million, attributable to legal and commitment fees incurred in connection with our aircraft and engine financing as well as aircraft debt refinancing.

Income Taxes

In our three months ended June 30, 2018, our effective tax rate was 23.9% compared to 37.0% in our three months ended June 30, 2017. Our tax rate can vary depending on changes in tax laws, adoption of accounting standards, the amount of income we earn in each state and the state tax rate applicable to such income, as well as any valuation allowance required on our state net operating losses.

The income tax provision for the three months ended June 30, 2018 results in an effective tax rate of 23.9%, which differs from the U.S. federal statutory rate of 35% through December 31, 2017 and 21% as of January 1, 2018 primarily due to a remeasurement of our net deferred tax liability due to federal tax law changes and the adoption of Accounting Standards Update (ASU) 2016-09. Other factors include changes in the valuation allowance against state net operating losses, expired state attributes and state apportionment and statutory rates.

The income tax provision for the three months ended June 30, 2017 results in an effective tax rate of 37.0%, which differs from the U.S. federal statutory rate of 35% primarily due to state taxes, changes in the valuation allowance against state net operating losses, expired state attributes, and the benefit resulting from changes in state apportionment and statutory rates.

On December 22, 2017, the President signed into law the legislation colloquially known as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act incorporates several new provisions that will have an impact on our financial statements. Most notably, the Tax Act decreased the federal statutory rate to 24.5% for the year ending September 30, 2018, and 21% for the years ending September 30, 2019 and forward. The decrease in federal statutory rate resulted in a net tax benefit due to the remeasurement of our net deferred tax liability. The change in our future effective tax rate is not anticipated to have an effect on our taxes until all of our U.S. federal net operating losses and credits have been utilized.

Additional provisions of the Tax Act that may impact our financial statements include 100% expensing of qualified property placed in service after September 27, 2017 and before January 1, 2023, refundable minimum tax credits over a four year period, net interest expense deductions limited to 30% of earnings before interest, taxes, depreciation, and amortization through 2021 and of earnings before interest and taxes thereafter, and net operating losses incurred in tax years beginning after December 31, 2017 are only allowed to offset up to 80% of a taxpayer’s taxable income. These net operating losses are allowed to be carried forward indefinitely.

We continue to maintain a valuation allowance on a portion of our state net operating losses in jurisdictions with shortened carryforward periods or in jurisdictions where our operations have significantly decreased as compared to prior years in which the net operating losses were generated.

As of September 30, 2017, we had aggregate federal and state net operating loss carryforwards of approximately $299.8 million and $172.3 million, which expire in 2027-2036 and 2018-2037, respectively, with approximately $20.1 million of state net operating loss carryforwards expiring in 2018. The net operating loss carryforward increased by an estimated $48.2 million for the three months ended June 30, 2018.

Nine Months Ended June 30, 2018 Compared to Nine Months Ended June 30, 2017

We had operating income of $30.9 million in our nine months ended June 30, 2018 compared to operating income of $77.6 million in our nine months ended June 30, 2017. Our operating results for the nine months ended June 30, 2018 reflected an increase in contract revenue primarily related to the addition of 10 E-175 aircraft under our United Capacity Purchase Agreement, which was partially offset by reduced flying in our CRJ fleet. We also experienced an increase in flight operations expense driven by an increase in pilot training and related expenses and an increase in premium pilot pay to incentivize pilots to fly additional routes until additional pilots complete their training.

 

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Our maintenance expense decreased due to the timing of significant maintenance events, including non-pass through engine overhauls, which occurred less frequently in our nine months ended June 30, 2018 than in same period during 2017.

We recorded two non-cash one-time adjustments in the nine months ended June 30, 2018. The first was $15.1 million of lease termination expense related to our acquisition of nine CRJ-900 aircraft which were previously leased under our GECAS Lease Facility. The second transaction related to an increase in the value of our SARs associated with an increase as well as a change in accounting methodology from the intrinsic value method to fair value method. These changes resulted in a general and administrative expense of $11.1 million.

In our nine months ended June 30, 2018, we had net income of $13.9 million compared to net income of $27.3 million in our nine months ended June 30, 2017. Our nine months ended June 30, 2018 results reflected a decrease in net income of $13.4 million primarily related to lease termination expense, an increase in general and administrative expense due to change in the value of our SARs and an increase in flight operations expense driven by an increase in pilot training expense and premium pilot pay offset by a reduction in maintenance expense and income tax benefits resulting from changes in tax laws.

Operating Revenues

 

		Nine Months Ended June 30,
		2018				2017				Change
Operating revenues ($ in thousands):
Contract		$	470,820			$	467,121			$	3,699				0.8	%
Pass-through and other			33,243				19,161				14,082				73.5	%
Total operating revenues		$	504,063			$	486,282			$	17,781				3.7	%
Operating data:
Available seat miles—ASMs (thousands)			7,061,658				7,213,852				(152,194	)			-2.1	%
Block hours			298,498				299,974				(1,476	)			-0.5	%
Revenue passenger miles—RPMs (thousands)			5,602,722				5,635,415				(32,693	)			-0.6	%
Average stage length (miles)			563				570				(7	)			-1.2	%
Contract revenue per available seat mile—CRASM (in cents)		¢	6.67			¢	6.48			¢	0.19				2.9	%
Passengers			9,823,231				9,757,772				65,459				0.7	%

Total operating revenue increased by $17.8 million, or 3.7%, during the nine months ended June 30, 2018 as compared to our nine months ended June 30, 2017. Contract revenue increased by $3.7 million, or 0.8%, primarily due to an increase in flying with our expanded E-175 fleet, higher block hour compensation, primarily driven by the aircraft added to our fleet, which was partially offset by reduced flying in our CRJ fleet. Our block hours flown during the nine months ended June 30, 2018 decreased 0.5% over the same period in 2017, primarily due to reduced flight schedules caused by increased pilot training times partially offset by increased flying with our expanded E-175 fleet. Our pass-through and other revenue increased during our nine months ended June 30, 2018 by $14.1 million, or 73.5%, primarily due to pass-through maintenance costs related to our E-175 fleet.

 

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Operating Expenses

 

		Nine Months Ended June 30,
		2018				2017				Change
Operating expenses ($ in thousands):
Flight operations		$	155,602			$	110,302			$	45,300				41.1	%
Fuel			349				614				(265	)			-43.2	%
Maintenance			154,046				164,239				(10,193	)			-6.2	%
Aircraft rent			54,557				54,334				223				0.4	%
Aircraft and traffic servicing			2,592				2,758				(166	)			-6.0	%
General and administrative			43,333				31,210				12,123				38.8	%
Depreciation and amortization			47,611				45,220				2,391				5.3	%
Lease Termination			15,109				—				15,109				100.0	%
Total operating expenses		$	473,199			$	408,677			$	64,522				15.8	%
Operating data:
Available seat miles—ASMs (thousands)			7,061,658				7,213,852				(152,194	)			-2.1	%
Block hours			298,498				299,974				(1,476	)			-0.5	%
Average stage length (miles)			563				570				(7	)			-1.2	%
Departures			164,825				166,473				(1,648	)			-1.0	%

Flight Operations. Flight operations expense increased $45.3 million, or 41.1%, to $155.6 million for our nine months ended June 30, 2018 compared to the same period in 2017. The increase was primarily driven by an increase in pilot training related expenses, an increase in premium pilot pay to incentivize pilots to fly additional routes until additional pilots complete their training, a one-time, $2.5 million non-cash vacation accrual and additional pilot and flight attendance wages related to our new collective bargaining agreements.

Fuel. Fuel expense decreased $0.3 million, or 43.2%, to $0.3 million for our nine months ended June 30, 2018 compared to the same period in 2017. The decrease was primarily driven by a smaller number of ferry flights and maintenance fuel in our Phoenix hub. In our nine months ended June 30, 2018 and 2017, all fuel costs related to flying under our capacity purchase agreements were directly paid to suppliers by our major airline partners.

Maintenance. Aircraft maintenance costs decreased $10.2 million, or 6.2%, to $154.0 million for our nine months ended June 30, 2018 compared to the same period in 2017. This decrease was primarily driven by a decrease in engine overhaul expense, due to the timing of engine overhaul events, which occurred less frequently in the nine months ended June 30, 2018 than in the same period in 2017. Additionally, the decrease was due to a decrease in rotable and expendable parts and labor and other expense. The decrease was partially offset by an increase in pass through engine overhaul and c-check expense. Total pass-through maintenance expense reimbursed by our major airline partners increased by $15.7 million from the nine months ended June 30, 2018 compared to the same period in 2017.

The following table presents information regarding our maintenance costs during our nine months ended June 30, 2018 and 2017 (in thousands):

 

		Nine Months Ended June 30,
		2018				2017				Change
Engine overhaul		$	36,434			$	53,547			$	(17,113	)			-32.0	%
Pass-through engine overhaul			9,780				—				9,780				100.0	%
C-check			12,473				14,251				(1,778	)			-12.5	%
Pass-through C-check			7,333				2,638				4,695				178.0	%
Component contracts			24,255				23,885				370				1.5	%
Rotable and expendable parts			17,326				20,952				(3,626	)			-17.3	%
Other pass-through			5,641				4,387				1,254				28.6	%
Labor and other			40,804				44,579				(3,775	)			-8.5	%
Total		$	154,046			$	164,239			$	(10,193	)			6.2	%

 

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Aircraft Rent. Aircraft rent expense increased $0.2 million, or 0.4%, to $54.6 million for our nine months ended June 30, 2018 compared to the same period in 2017. The increase is attributable to an increase in engine rent.

Aircraft and Traffic Servicing. Aircraft and traffic servicing expense decreased $0.2 million, or 6.0%, to $2.6 million for our nine months ended June 30, 2018 compared to the same period in 2017. The decrease is primarily due to a decrease in interrupted trip expense offset slightly by an increase in pass-through regulatory charges. For our nine months ended June 30, 2018 and 2017, 53.0% and 47.9%, respectively, of our aircraft and traffic servicing expenses were reimbursed by our major airline partners.

General and Administrative. General and administrative expense increased $12.1 million, or 38.8%, to $43.3 million for our nine months ended June 30, 2018 compared to the same period in 2017. The increase is primarily related to a one-time, non-cash $11.1 million expense related to an increase in the value of our stock appreciation rights (“SARS”) associated with an increase in fair value of our common stock.

Depreciation and Amortization. Depreciation and amortization expense increased $2.4 million, or 5.3%, to $47.6 million for our nine months ended June 30, 2018 compared to the same period in 2017. The increase is attributable to an increase in depreciation expense related to our purchase of spare engines.

Lease Termination. Lease termination expense increased $15.1 million, or 100.0%, for our nine months ended June 30, 2018, compared to the same period in 2017. The increase was related to our acquisition of nine CRJ-900 aircraft which were previously leased under our GECAS Lease Facility.

Other Expense

Other expense increased by $7.6 million, or 22.3%, to $41.7 million for our nine months ended June 30, 2018, compared to the same period in 2017. The increase is primarily due to an increase in interest expense of $5.7 million related to the financing of 23 spare engines, financing of 9 CRJ-900 which were previously leased under the GECAS Lease Facility, $0.2 million in costs related to refinancing of nine fifteen CRJ-900 aircraft, our line of credit with CIT, a deferment of certain payments under our RASPRO Lease Facility, engine overhaul financing and higher LIBOR rates. Our expenses related to debt financing amortization were also higher by $1.7 million, attributable to legal and commitment fees incurred in connection with our aircraft and engine financing and as well as aircraft debt refinancing.

Income Taxes

In our nine months ended June 30, 2018, our effective tax rate was 228.2% compared to 37.2% in our nine months ended June 30, 2017. Our tax rate can vary depending on changes in tax laws, adoption of accounting standards, the amount of income we earn in each state and the state tax rate applicable to such income, as well as any valuation allowance required on our state net operating losses.

The income tax provision for the nine months ended June 30, 2018 results in an effective tax rate of 228.2%, which differs from the U.S. federal statutory rate of 35% through December 31, 2017 and 21% as of January 1, 2018 primarily due to a remeasurement of our net deferred tax liability due to federal tax law changes and the adoption of Accounting Standards Update (ASU) 2016-09. Other factors include changes in the valuation allowance against state net operating losses, expired state attributes and state apportionment and statutory rates.

The income tax provision for the nine months ended June 30, 2017 results in an effective tax rate of 37.2%, which differs from the U.S. federal statutory rate of 35% primarily due to state taxes, changes in the valuation allowance against state net operating losses, expired state attributes, and the benefit resulting from changes in state apportionment and statutory rates.

On December 22, 2017, the President signed into law the legislation colloquially known as the Tax Cut and Jobs Act (the “Tax Act”). The Tax Act incorporates several new provisions that will have an impact on our financial statements. Most notably, the Tax Act decreased the federal statutory rate to 24.5% for the year ending September 30, 2018, and 21% for years ending September 30, 2019 and forward. This decrease in federal statutory resulted in a net tax benefit due to the remeasurement of our net deferred tax liability. The change in our future effective tax rate is not anticipated to have an effect on our cash tax until all of our U.S. federal net operating losses and credits have been utilized.

Additional provisions of the Tax Act that may impact our financial statements include 100% expensing of qualified property placed in service after September 27, 2017 and before January 1, 2023, refundable minimum tax credits over a four year period, net interest expense deductions limited to 30% of earnings after interest, taxes, depreciation, and amortization through 2021 and of earnings before interest and taxes thereafter, and net operating losses incurred in tax years beginning after December 31, 2017 are only allowed to offset up to 80% of a taxpayer’s taxable income. These net operating losses are allowed to be carried forward indefinitely.

 

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We continue to maintain a valuation allowance on a portion of our state net operating losses in jurisdictions with shortened carryforward periods or in jurisdictions where our operations have significantly decreased as compared to prior years in which the net operating losses were generated.

As of September 30, 2017, we had aggregate federal and state net operating loss carryforwards of approximately $299.8 million and $172.3 million, which expire in 2027-2036 and 2018-2037, respectively, with approximately $20.1 million of state net operating loss carryforwards expiring in 2018. The net operating loss carryforward increased by an estimated $111.4 million as of the nine months ended June 30, 2018 resulting in a total net operating loss carryforward of $411.2 million.

Adjusted EBITDA and Adjusted EBITDAR

The following table presents a reconciliation of net (loss) income to estimated Adjusted EBITDA and Adjusted EBITDAR for the period presented:

 

		Three Months Ended June 30,								Nine Months Ended June 30,
		2018				2017				2018				2017
Reconciliation (in thousands):
Net (loss) income		$	(11,135	)		$	15,433			$	13,861			$	27,347
Income tax (benefit) expense			(3,495	)			9,065				(24,676	)			16,175
(Loss) income before taxes		$	(14,630	)		$	24,498			$	(10,815	)		$	43,522
Revaluation of liability awards(1)			11,084				—				11,084				—
Lease termination costs(2)			15,109				—				15,109				—
Adjusted income before taxes			11,563				24,498				15,378				43,522
Interest expense			14,118				11,819				41,592				33,659
Depreciation and amortization			16,013				15,620				47,611				45,220
Adjusted EBITDA			41,694				51,937				104,581				122,401
Aircraft rent			17,975				18,274				54,557				54,334
Adjusted EBITDAR			59,669				70,211				159,138				176,735

 

(1)

Our financial results reflect a one-time, non-cash increase in accrued compensation of approximately $13.5 million related to an increase in the value of our stock appreciation rights (“SARs”) associated with an increase in fair value of our common stock as well as a change in accounting methodology from the intrinsic value method to the fair value method. These changes resulted in a general and administrative expense of approximately $11.1 million as well as an offset of approximately $2.4 million to retained earnings as a result of the change in accounting methodology.

(2)

Our financial results include a one-time, non-cash lease termination expense of $15.1 million related to our acquisition of nine CRJ-900 aircraft, which were previously leased under our aircraft lease facility with Wells Fargo Bank Northwest, National Association, as owner trustee and lessor (the “GECAS Lease Facility”), for $76.5 million.

Liquidity and Capital Resources

Sources and Uses of Cash

We require cash to fund our operating expenses and working capital requirements, including outlays for capital expenditures, aircraft pre-delivery payments, maintenance, aircraft rent and to pay debt service obligations, including principal and interest payments. Our cash needs vary from period to period primarily based on the timing and costs of significant maintenance events. Our principal sources of liquidity are cash on hand, cash generated from operations and funds from external borrowings. In the near term, we expect to fund our primary cash requirements through cash generated from operations and cash and cash equivalents on hand. We also have the ability to utilize our credit and guaranty agreement (the “CIT Revolving Credit Facility”) pursuant to which the CIT Lenders committed to lend to Mesa Airlines and Mesa Air Group—Airline Inventory Management, LLC, (“MAG-AIM”) revolving loans in the aggregate principal amount of up to $35.0 million, which was paid down with proceeds from the initial public offering (“IPO”) of our common stock on August 14, 2018.

 

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We believe that the key factors that could affect our internal and external sources of cash include:

 

•

Factors that affect our results of operations and cash flows, including the impact on our business and operations as a result of changes in demand for our services, competitive pricing pressures, and our ability to achieve further reductions in operating expenses; and

 

•

Factors that affect our access to bank financing and the debt and equity capital markets that could impair our ability to obtain needed financing on acceptable terms or to respond to business opportunities and developments as they arise, including interest rate fluctuations, macroeconomic conditions, sudden reductions in the general availability of lending from banks or the related increase in cost to obtain bank financing, and our ability to maintain compliance with covenants under our debt agreements in effect from time to time.

Our ability to service our long-term debt obligations, including our equipment notes, to remain in compliance with the various covenants contained in our debt agreements and to fund working capital, capital expenditures and business development efforts will depend on our ability to generate cash from operating activities, which is subject to, among other things, our future operating performance, as well as to other factors, some of which may be beyond our control.

If we fail to generate sufficient cash from operations, we may need to raise additional equity or borrow additional funds to achieve our longer-term objectives. There can be no assurance that such equity or borrowings will be available or, if available, will be at rates or prices acceptable to us.

We believe that cash flow from operating activities coupled with existing cash and cash equivalents, short-term investments and existing credit facilities will be adequate to fund our operating and capital needs, as well as enable us to maintain compliance with our various debt agreements, through at least the next 12 months. To the extent that results or events differ from our financial projections or business plans, our liquidity may be adversely impacted.

Prior to our IPO, our operations have been financed primarily by cash flow from operating activities and funds from external borrowings. As of June 30, 2018, we had $41.7 million in cash and cash equivalents. In connection with our IPO, we issued and sold an aggregate of 9,630,000 shares of common stock (exclusive of 1,444,500 shares of common stock from the exercise of the over-allotment option granted to the underwriters which has not been exercised as of September 4, 2018) at a price of $12.00 per share. We received proceeds of $104.1 million, net of underwriting discounts and commissions and estimated offering costs

During the ordinary course of business, we evaluate our cash requirements and, if necessary, adjust operating and capital expenditures to reflect the current market conditions and our projected demand. Our capital expenditures are primarily directed toward our aircraft fleet and flight equipment. In our nine months ended June 30, 2018, we paid $98.5 million in capital expenditures primarily related to the purchase of nine CRJ-900 aircraft, which were previously leased, and three spare engines. Our capital expenditures for the nine months ended June 30, 2018 were $5.3 million net of aircraft and spare engine financing. Our capital expenditures, net of aircraft and spare engine financing, have historically been approximately 1.2% of annual revenues and we expect to continue to incur capital expenditures to support our business activities. Future capital expenditures may be impacted by events and transactions that are not currently forecasted.

As of June 30, 2018, our principal sources of liquidity were cash and cash equivalents of $41.7 million. In addition, we had restricted cash of $3.8 million as of June 30, 2018. Restricted cash includes certificates of deposit that secure letters of credit issued for particular airport authorities as required in certain lease agreements. Furthermore, as of June 30, 2018, we also had $833.2 million in secured indebtedness incurred in connection with our financing of 74 total aircraft. Primary uses of liquidity are capital expenditures, aircraft pre-delivery payments and debt repayments. As of June 30, 2018, we had $148.8 million of short-term debt, excluding capital leases, and $835.3 million of long-term debt excluding capital leases.

Sources of cash for the nine months ended June 30, 2018 were primarily cash flows from operations of $63.2 million. This positive cash flow was driven by receipts from performance under our capacity purchase agreements.

Restricted Cash

As of June 30, 2018, we had $3.8 million in restricted cash. We have an agreement with a financial institution for a $6.0 million letter of credit facility and to issue letters of credit for landing fees, worker’s compensation insurance and other business needs. Pursuant to the agreement, $3.8 million of outstanding letters of credit are required to be collateralized by amounts on deposit.

 

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Cash Flows

The following table presents information regarding our cash flows for each of the nine months ended June 30, 2018 and 2017:

 

		Nine Months Ended June 30,
		2018				2017
(in thousands)
Net cash provided by operating activities		$	63,163			$	38,740
Net cash used in investing activities			(101,446	)			(67,659	)
Net cash provided by financing activities			23,226				14,153
Net decrease in cash and cash equivalents			(15,057	)			(14,766	)
Cash and cash equivalents at beginning of period			56,788				37,686
Cash and cash equivalents at end of period		$	41,731			$	22,920

Net Cash Flow Provided By Operating Activities

During our nine months ended June 30, 2018, cash flow provided by operating activities of $63.2 million reflects our growth and execution of our strategic initiatives. We had net income of $13.9 million adjusted for the following significant non-cash items: depreciation and amortization of $47.6 million, amortization of stock-based compensation of $1.2 million, deferred income taxes of $(22.1) million, amortization of unfavorable lease liabilities and deferred credits of $(8.3) million and amortization of debt financing costs and accretion of interest on non-interest bearing subordinated notes of $3.6 million. We had net change of $11.9 million within other net operating assets and liabilities largely driven by adjusting the share based compensation liability to fair value during our nine months ended June 30, 2018.

During our nine months ended June 30, 2017, cash flow provided by operating activities of $38.7 million reflects our growth and execution of our strategic initiatives. We had net income of $27.3 million adjusted for the following significant non-cash items: depreciation and amortization of $45.2 million, amortization of stock-based compensation of $0.9 million, deferred income taxes of $16.2 million, amortization of unfavorable lease liabilities and deferred credits of $(7.9) million and amortization of debt financing costs and accretion of interest on non-interest bearing subordinated notes of $1.3 million. We had net outflows of $(45.1) million within other net operating assets and liabilities largely driven by aircraft lease payments during our nine months ended June 30, 2017.

Net Cash Flows Used In Investing Activities

During our nine months ended June 30, 2018, net cash flow used in investing activities totaled $(101.4) million. We invested $98.5 million in nine aircraft, three spare engines and aircraft improvements.

During our nine months ended June 30, 2017, net cash flow used in investing activities totaled $(67.6) million. We invested $64.8 million in 12 spare engines and aircraft improvements, offset partially by returns of equipment deposits.

Net Cash Flows Provided By Financing Activities

During our nine months ended June 30, 2018, net cash flow provided by financing activities was $23.2 million. We received $187.7 million in proceeds from long-term debt primarily related to purchasing nine aircraft, refinancing debt on aircraft, as well as spare aircraft engine and aircraft engine kit financing. We made $158.2 million of principal repayments on long-term debt during the year. We also incurred $5.8 million of costs related to debt financing and $0.5 million of costs related to the repurchase of shares of our common stock.

During our nine months ended June 30, 2017, net cash flow provided by financing activities was $14.2 million. We received $133.5 million in proceeds from long-term debt primarily related to spare aircraft engine and aircraft engine kit financing. We made $116.1 million of principal repayments on long-term debt and incurred $2.4 million of costs related to debt financing and $0.8 million of costs related to the repurchase of shares of our common stock.

 

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Commitments and Contractual Obligations

As of June 30, 2018, we had $1,448.3 million of long-term debt (including principal and projected interest obligations) and operating lease obligations (including current maturities).

The following table sets forth our cash obligations as of June 30, 2018:

 

						Payment Due for Year Ending September 30,
		Total				2018 - Remaining				2019				2020				2021				2022				Thereafter
(in thousands)
Aircraft notes		$	1,021,027			$	43,584			$	158,471			$	154,396			$	148,467			$	132,704			$	383,405
Engine notes			150,434				11,581				41,198				38,253				28,470				29,803				1,129
Operating lease obligations			236,497				18,876				65,456				47,114				45,681				31,090				28,280
Working capital line of credit			27,621				397				27,224				—				—				—				—
Capital Leases			12,680				510				2,040				2,540				2,640				2,640				2,310
Total		$	1,448,259			$	74,948			$	294,389			$	242,303			$	225,258			$	196,237			$	415,124

Critical Accounting Policies and Estimates

We prepare our condensed financial statements in accordance with GAAP. The preparation of condensed financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ significantly from the estimates made by our management.

Except with respect to our shared-based compensation included in Note 2: “Summary of Significant Accounting Policies” under the heading “Change in Accounting Policy” in the notes to our unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q there have been no material changes to our critical accounting policies and estimates from those disclosed in our financial statements and the related notes and other financial information included in our final prospectus filed with the Securities and Exchange Commission pursuant to Rule 424(b)(4) under the Securities Act of 1933, as amended, on August 10, 2018.

In April 2012, the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”) was enacted. Section 107 of the JOBS Act provides that an “emerging growth company” may take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. Therefore, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards, and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

Off-Balance Sheet Arrangements

We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the Securities and Exchange Commission (the “SEC”).

Recently Issued Accounting Pronouncements

A description of recently issued accounting pronouncements that may potentially impact our financial position and results of operations is disclosed in Note 2: “Summary of Significant Accounting Policies” to our unaudited condensed financial statements included in this Quarterly Report on Form 10-Q.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are subject to market risks in the ordinary course of our business. These risks include interest rate risk and, on a limited basis, commodity price risk with respect to foreign exchange transactions. The adverse effects of changes in these markets could pose a potential loss as discussed below. The sensitivity analysis provided does not consider the effects that such adverse changes may have on overall economic activity, nor does it consider additional actions we may take to mitigate our exposure to such changes. Actual results may differ.

 

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