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SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

For the quarterly period-ended June 30, 2003

or

Commission File Number 0-15495

Mesa Air Group, Inc.

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 last 90 days. Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o

     On August 8, 2003 the registrant had outstanding 31,493,172 shares of Common Stock.

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INDEX

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PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

MESA AIR GROUP, INC

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(in thousands, except per share amounts)

See accompanying notes to consolidated financial statements.

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MESA AIR GROUP, INC.

CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in thousands except share amounts)

See accompanying notes to consolidated financial statements.

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MESA AIR GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)

See accompanying notes to consolidated financial statements.

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MESA AIR GROUP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.

Business and Basis of Presentation

     The accompanying unaudited, consolidated financial statements of Mesa Air Group, Inc. (“Mesa” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for a complete set of financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results for the unaudited three and nine-month periods have been made. Operating results for the three and nine-month periods ended June 30, 2003, are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2003. These consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the fiscal year ended September 30, 2002.

     The consolidated financial statements include the accounts of Mesa Air Group, Inc. and its wholly owned operating subsidiaries: Mesa Airlines, Inc. (“Mesa”), Freedom Airlines, Inc. (“Freedom”), Air Midwest, Inc. (“Air Midwest”), CCAir, Inc. (“CCAir”), MPD, Inc. d/b/a Mesa Pilot Development (“MPD”), Regional Aircraft Services, Inc. (“RAS”), MAGI Insurance, Ltd. (“MAGI”), Mesa Air Group – Aircraft Inventory Management, LLC (“MAG-AIM”) as well as the accounts of UFLY, LLC (“UFLY”), a 52% owned subsidiary of which the Company is able to exercise significant influence. CCAir ceased operations on November 3, 2002. All significant intercompany balances and transactions have been eliminated in consolidation.

2.

Air Transportation Safety and System Stabilization Act

     In September 2001, the Company recorded as non-operating income $14.7 million associated with amounts claimed under the Air Transportation Safety and System Stabilization Act (the “Act”). In June 2003, the Company finalized its claim with the Department of Transportation (“DOT”). Pursuant to the settlement, the Company agreed to return approximately $1.8 million of amounts previously received under the Act. As such, included in other expense is approximately $4.1 million, which included approximately $2.3 million the Company had recorded as a receivable and the $1.8 million the Company agreed to return to the DOT. Amounts to be returned to the DOT are payable in six monthly installments of $0.3 million beginning in July 2003.

3.

Minority Interest

     In 2001, the Company entered into an agreement to form UFLY, for the purpose of making strategic investments in US Airways, Inc. In 2002, UFLY was formally established and was capitalized with $10.0 million. The Company currently owns 52% of UFLY. The Company’s Chairman and CEO is a minority shareholder/owner and the managing member of UFLY. He receives no additional remuneration or compensation in connection with his role as the managing member of UFLY. Amounts included in the consolidated statements of income as minority interest reflect the after-tax portion of earnings of UFLY that are applicable to the minority interest partners. For the nine months ended June 30, 2002, UFLY had investment losses of $1.7 million. Investment gains in fiscal 2003 were less than $0.1 million. At June 30, 2003, UFLY had less than $0.1 million in investment assets. The Company intends to dissolve UFLY in the fourth quarter of fiscal 2003.

4.

Segment Reporting

     Statement of Financial Accounting Standard (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires disclosures related to components of a company for which separate financial information is available that is evaluated regularly by a company’s chief operating decision maker in deciding the allocation of resources and assessing performance. The Company has four airline operating subsidiaries, Mesa Airlines, Freedom Airlines, Air Midwest and CCAir and various other subsidiaries organized to provide support for the Company’s airline operations. The Company has aggregated these operating segments into four reportable segments. Mesa and Freedom primarily operate the Company’s regional jets. Air Midwest operates the Company’s Beech 1900 turboprop aircraft. CCAir, which ceased operations on November 3, 2002, operated a mixed fleet of turboprop aircraft. The Other reportable segment includes Mesa Air Group, RAS, MPD, MAG-AIM, MAGI and UFLY, all of which support the Company’s operating subsidiaries.

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     Mesa and Freedom provide passenger service with regional jets under revenue-guarantee contracts with America West, US Airways and Frontier Airlines. Mesa Airlines also provides passenger service with Dash-8 aircraft under a revenue-guarantee contract with America West, and commencing July 6, 2003, with United Airlines. Mesa and Freedom provide service to 103 destinations throughout the United States, Canada and Mexico. As of June 30, 2003, Mesa and Freedom operated a fleet of 99 aircraft – 55 CRJs, 32 ERJs and 12 Dash-8’s. In July 2003, Mesa discontinued its pro-rate Dash-8 agreement with US Airways and commenced operating these aircraft with United Airlines under a revenue-guarantee agreement.

     Air Midwest provides passenger service with Beechcraft 1900D aircraft under pro-rate contracts with America West, US Airways and Midwest Airlines. Air Midwest provides service to 68 destinations in the United States. As of June 30, 2003, Air Midwest operated a fleet of 42 Beechcraft 1900D turboprop aircraft.

     CCAir provided passenger service with Dash-8 and Jetstream 31 turboprop aircraft under a pro-rate revenue contract with US Airways. CCAir discontinued its use of Jetstream aircraft in February 2002, and discontinued its use of Dash-8 aircraft in November 2002, when it ceased operations.

     The Other category consists of Mesa Air Group, Inc. (holding company), MPD, MAG-AIM, RAS, MAGI and UFLY. Mesa Air Group performs all administrative functions not directly attributable to any specific operating company. These administrative costs are allocated to the operating companies based upon specific criteria including headcount, ASM’s and other operating statistics. MPD operates pilot training programs in conjunction with San Juan College in Farmington, New Mexico and Arizona State University in Tempe, Arizona. Graduates of these training programs are eligible to be hired by the Company’s operating subsidiaries. MAG-AIM, which was formed in the second quarter of fiscal 2003, primarily provides inventory management services for the Company’s operating subsidiaries; hence its revenues are primarily derived from intercompany sales. These intercompany sales are eliminated in consolidation. RAS primarily provides repair services to the Company’s operating subsidiaries. MAGI is a captive insurance company located in Barbados. UFLY was established for the purpose of making strategic investments in other airline’s common stock.

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5.

Marketable Securities

     SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” requires that all applicable investments be classified as trading securities, available for sale securities or held to maturity securities. All of the Company’s investments are classified as trading securities during the periods presented and therefore, are carried at market value with changes in value reflected in current period operations.

     The Company has a cash management program that provides for the investment of excess cash balances primarily in short-term money market instruments and intermediate-term debt instruments.

     In the past, the Company has taken short positions in common equity securities. Unlike traditional investing where the investor’s risk is limited to the amount of their investment, when stocks are sold short, there is no limit to the potential price appreciation of the stock, thus there is no limit to the potential loss. The Company marks short positions to market at each reporting period with the associated gain or loss reflected in other income (expense) in the statement of operations. Included in marketable securities are liabilities related to short positions on common equity securities of $2.8 million and $7.2 million at June 30, 2003 and September 30, 2002, respectively. Unrealized holding losses that relate to trading securities (including short positions) held at June 30, 2003 and September 30, 2002 were $1.3 million and $5.2 million, respectively.

6.

Accounts Receivable from Code-Share Partners

     The Company has code-share agreements with America West, US Airways, Frontier and Midwest Airlines. Approximately 98% of the Company’s consolidated passenger revenue for the three and nine-months ended June 30, 2003 and 2002 were derived from these agreements. Accounts receivable from the Company’s code-share partners were 65% and 57% of total gross accounts receivable at June 30, 2003 and September 30, 2002, respectively.

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7.

Derivative Financial Instruments

     The Company accounts for its fuel hedge derivative instruments as cash flow hedges in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. SFAS No. 133 requires the Company to record all financial derivative instruments on its balance sheet at fair value. Derivatives that are not designated as hedges must be adjusted to fair value through income. If a derivative is designated as a hedge, the fair market value is recorded on the consolidated balance sheet. Changes in the fair value of the hedge that are considered to be effective, as defined, are recorded in “Accumulated Other Comprehensive Income.” These deferred gains and losses are recognized in income in the period in which the related aircraft fuel is purchased. Any portion of a change in a derivative’s fair value that is considered to be ineffective, as defined, is recorded immediately in “Other income (expense)” in the consolidated statement of operation. Any portion of a change in a derivative’s fair value that the Company excludes from its measurement of effectiveness is required to be recorded immediately in earnings.

     The Company is exposed to the effect of changes in the price and availability of aircraft fuel to the extent such exposure is not passed through to its revenue-guarantee code-share partners. Currently approximately 87% of the Company’s fuel costs are associated with the Company’s America West code-share and US Airways regional jet service agreements, thus these companies bear the risk of increases in the Company’s fuel costs under these agreements. From time-to-time the Company utilizes financial derivative instruments as a hedge to mitigate its exposure to the remaining (at risk) aircraft fuel cost. Because aircraft fuel is not traded on organized futures exchanges, liquidity for aircraft fuel hedging is limited. However, the airline industry has found that heating oil contracts are effective instruments for hedging aircraft fuel. The Company does not purchase or hold any derivative financial instruments for trading purposes.

     As of June 30, 2003, the Company has hedged approximately 5% of its estimated (at risk) pro-rate fuel expense for the fourth quarter of fiscal 2003. The Company has recorded approximately $24,000 in unrealized gains, net of tax, in “Accumulated Other Comprehensive Income” related to these fuel hedges. These unrealized gains are recognized in income in the period in which the related aircraft fuel is purchased.

8.

Aircraft and Parts Held for Sale

     At June 30, 2003, aircraft and parts held for sale consists of expendable and rotable inventory that the Company has deemed to be surplus to its operating needs. Excess rotable and expendable inventory is valued at net realizable value, less cost to sell. Included in this account at September 30, 2002, were three Beechcraft 1900D aircraft that were returned to the manufacturer in 2003.

9.

Deferred Credits

     The Company accounts for aircraft purchase incentives provided by the aircraft manufacturers as deferred credits. These credits are amortized over the life of the related lease. Deferred credits include the value of aircraft purchase incentives, such as credits that may be used to purchase spare parts, pay for training expenses or reduce other aircraft operating costs. In addition, during May 2001, Mesa restructured various past contractual claims it had against Bombardier Regional Aircraft Division. Under this restructuring, Mesa initially received $25.2 million and received $1.1 million per month through April 2003 to resolve these outstanding claims. These amounts are reflected in Deferred Credits at June 30, 2003.

10.

Notes Payable and Long-Term Debt

     In June 2003, the Company completed the private placement of senior convertible notes due 2023, which resulted in gross proceeds of $100.1 million to the Company. Cash interest is payable on the notes at a rate of 2.4829% per year on the principal amount at maturity, payable semiannually in arrears on June 16 and December 16 of each year, beginning December 16, 2003, until June 16, 2008. After that date, the Company will not pay cash interest on the notes prior to maturity, and the notes will begin accruing interest at a rate of 6.25% until maturity. On June 16, 2023, the maturity date of the notes, the principal amount of each note will be $1,000. The aggregate amount due at maturity, including interest accrued from June 16, 2008, will be $252 million. Each of the Company’s wholly owned domestic subsidiaries will guarantee the notes on an unsecured senior basis. The notes and the note guarantees are senior unsecured obligations and rank equally with the Company’s existing and future senior unsecured indebtedness. The notes and the note guarantees are junior to any secured obligations of the Company and any of its wholly owned subsidiaries to the extent of the collateral pledged.

     The notes are convertible into shares of the Company’s common stock at a conversion rate of 39.727 shares per $1,000 in principal amount at maturity of the notes which equals an initial conversion price of approximately $10.00 per share. This conversion rate is

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subject to adjustment in certain circumstances. Holders of the notes may convert their notes only if: (i) the sale price of our common stock exceeds 110% of the accreted conversion price for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the preceding quarter; (ii) prior to June 16, 2018, the trading price for the notes falls below certain thresholds; (iii) the notes have been called for redemption; or (iv) specified corporate transactions occur. The Company may redeem the notes, in whole or in part, beginning on June 16, 2008, at a redemption price equal to the issue price, plus accrued original issue discount, plus any accrued and unpaid cash interest. The holders of the notes may require the Company to repurchase the notes on June 16, 2008 at a price of $397.27 per note plus accrued and unpaid cash interest, if any, on June 16, 2013 at a price of $540.41 per note plus accrued and unpaid cash interest, if any, and on June 16, 2018 at a price of $735.13 per note plus accrued and unpaid cash interest, if any. It is our intent to settle the notes in cash if the holders require repurchase in 2008, 2013 or 2018. The Company has agreed to file a shelf registration statement with the U.S. Securities and Exchange Commission covering the resale of the notes and the underlying common stock.

     Net proceeds from the offering totaled $97.2 million. Approximately $40.0 million of these net proceeds are restricted to collateralize letters of credit and are reported as restricted cash in the Consolidated Balance Sheet as of June 30, 2003.

     Repayment of the convertible notes (collectively, the “Notes”) is jointly and severally guaranteed on an unconditional basis by the Company’s wholly owned domestic subsidiaries. Except as otherwise specified in the indentures pursuant to which the Notes were issued, there are no restrictions on the ability of such subsidiaries to transfer funds to the Company in the form of cash dividends, loans or advances. General provisions of applicable state law, however, may limit the ability of any subsidiary to pay dividends or make distributions to the Company in certain circumstances.

     Separate financial statements of the Company’s subsidiaries are not included herein because the aggregate assets, liabilities, earnings, and equity of the subsidiaries are substantially equivalent to the assets, liabilities, earnings, and equity of the Company on a consolidated basis; the subsidiaries are jointly and severally liable for the repayment of the Notes; and the separate financial statements and other disclosures concerning the subsidiaries are not deemed by the Company to be material to investors.

     The Company also has a $35 million line of credit facility with Fleet Capital, which expires on December 7, 2003. The Fleet Capital line of credit is secured by certain of the Company’s inventory and receivables, with the amount available varying from time to time based on the then current value of the collateral. The agreement also contains a financial covenant that requires the maintenance of certain financial ratios related to fixed charge coverage and total debt to capital. The Company was in compliance with these covenants at June 30, 2003. The Company intends to use the facility for general working capital purposes. The Company also had $18.5 million in letters of credit outstanding at June 30, 2003, which reduced the amount available under our line of credit with Fleet. There were no other amounts outstanding under this facility at June 30, 2003. Based upon available collateral, $5.6 million remained available under the line at June 30, 2003. Fleet Capital has given the Company notice that it does not intend to renew the credit facility upon expiration. The Company is currently in discussions with several financial institutions to provide a similar line of credit upon expiration of the Fleet facility; however, given the recent increase in liquidity due to the convertible debt offering and the planned sale of aircraft inventory, the Company does not believe it is necessary to replace the expiring line of credit. In the event the Company does not obtain a replacement line of credit, it will be required to cash collateralize any letters of credit that remain outstanding at that time.

11.

Weighted Average Shares Outstanding

12.

Beechcraft 1900D Cost Reductions

     On February 7, 2002, the Company finalized an agreement with Raytheon Aircraft Credit Company (the “Raytheon Agreement”) to reduce the operating costs of its Beechcraft 1900D fleet. In connection with the Raytheon Agreement and subject to the terms and conditions contained therein, Raytheon agreed to provide up to $5.5 million in annual operating subsidy payments to the Company contingent upon satisfying certain spending requirements and, among other things, the Company remaining current on its payment obligations to Raytheon. Approximately $1.4 million was recorded as a reduction to flight operations, maintenance and interest

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expense during the three months ended June 30, 2003 and 2002. Approximately $4.1 million and $4.6 million was recorded as a reduction to flight operations, maintenance and interest expense during the nine months ended June 30, 2003 and 2002, respectively.

     In consideration for Raytheon’s financial accommodations, the Company granted Raytheon an option to purchase up to 233,068 warrants at a purchase price of $1.50 per warrant. Each warrant entitles the holder to purchase one share of common stock at an exercise price of $10.00 per share. Each of the warrants is exercisable at any time over a three-year period following its date of purchase. Absent an event of default by the Company in which case vesting is accelerated, options to purchase the warrants vest according to the following schedule: 13,401 warrants for fiscal year 2001; 116,534 warrants for fiscal year 2002; 58,267 warrants for fiscal year 2003 and 44,866 warrants for fiscal year 2004. As of June 30, 2003, Raytheon has exercised its option to purchase the 2001 and 2002 warrants. In accordance with the provisions of SFAS No. 123, the warrants were valued at $3.22 per warrant based upon their fair value using the Black-Scholes option pricing model.

13.

Impairment and Restructuring Charges (Credits)

     As a result of the notification by US Airways of their intent to cancel CCAir’s pro-rate contract effective November 3, 2003, CCAir ceased operations as of that date. As a result, the Company took a pretax restructuring and impairment charge of $19.8 million in the fourth quarter of fiscal 2002, including $7.8 million for future aircraft lease payments, $4.6 million in aircraft related return costs, $4.1 million to reduce the value of rotable and expendable inventory to fair market value less costs to sell, $1.7 million to reduce maintenance deposits held by a lessor to net realizable value, $0.9 million to write off the value of equipment and leasehold improvements and $0.7 million of severance and other employee related liabilities. Once operations ceased, CCAir stopped making lease payments on its fleet of Dash 8–100 aircraft. CCAir subsequently returned the aircraft to the lessors. At the time of the shutdown, it was the Company’s intention to maintain the legal entity of CCAir as well as its operating certificate with the possibility of either restructuring the airline and operating it under amended labor agreements in the future or affecting a sale of CCAir.

     In the second quarter of fiscal 2003, CCAir surrendered its operating certificate to the FAA and filed articles of dissolution with the State of Delaware. As a result of these events and CCAir’s lack of liquidity, it became clear that CCAir would be unable to pay any of its obligations. In light of CCAir’s inability to pay its obligations and the resulting dissolution, the Company reversed the restructuring charges recorded in the fourth quarter of fiscal 2002 by approximately $12 million. The reversal of these charges was precipitated by the dissolution of CCAir and the Company’s subsequent determination, after consultation with counsel, that the Company should not be held legally responsible for the obligations incurred solely by CCAir and not guaranteed by the Company. CCAir had an after tax loss of $2.9 million in the three-month period ended June 30, 2002, no income or loss in the three-month period ended June 30, 2003, and after tax income (loss) of $7.0 million and ($6.4) million in the nine-month periods ended June 30, 2003 and 2002, respectively.

     In the third quarter of fiscal 2003, the Company returned the two remaining B1900D aircraft permitted under its agreement with Raytheon. As a result of unanticipated increases in the cost of meeting the return conditions of these and previous aircraft, the Company recorded an additional impairment charge of $1.1 million in the second quarter of fiscal 2003.

     The remaining reserves are primarily related to the remaining lease payments and the future costs of returning two Shorts 360 aircraft the Company subleases to an operator in Europe.

     The changes in the impairment and restructuring charges for the periods ended June 30, 2003 and 2002, respectively, are as follows (in thousands):