RJET

Business Context and Reporting Period

Company: Mesa Air Group, Inc. (Mesa)
Filing Type: Form 10-K (Annual Report)
Period Ended: September 30, 2006
Business Overview: Mesa is a holding company whose subsidiaries operate as regional air carriers providing scheduled passenger and airfreight service. As of September 30, 2006, the company served 173 cities across 46 states, Canada, the Bahamas, and Mexico, operating a fleet of 191 aircraft with approximately 1,200 daily departures. Approximately 98% of consolidated passenger revenues were derived from code-share agreements with major carriers, primarily US Airways, United Airlines, and Delta Air Lines. The company also operates independent services, including "go!" in Hawaii.

Key Financial Metrics

Note: Net income for 2006 included a $12.1 million pretax bankruptcy settlement gain and $13.1 million in debt conversion costs.

Material Changes vs. Prior Period

• Revenue Growth: Operating revenues increased 17.7% to $1.337 billion, driven primarily by a $208.1 million increase in the Mesa/Freedom segment. This was largely due to a $155.8 million increase in fuel reimbursements from code-share partners.
• Expense Increases: Operating expenses rose 22.7% to $1.236 billion. Fuel expense increased 51.1% to $459.6 million due to a 44.7% rise in jet fuel prices (from $1.50 to $2.17 per gallon). Flight operations expenses increased 16.9% due to aircraft lease costs and training expenses associated with fleet transitions.
• Profitability Decline: Despite revenue growth, Net Income decreased 40.3% to $34.0 million. This decline was attributed to higher fuel costs, increased maintenance expenses, and significant one-time costs including $13.1 million in debt conversion costs and $11.3 million paid to noteholders during debt-to-equity conversions.
• Debt Reduction: Long-term debt decreased significantly as holders of $156.8 million in aggregate principal amount of Senior Convertible Notes due 2023 converted their notes into 6.2 million shares of common stock.
• Strategic Transition: The company completed the transition of aircraft out of Pre-Merger US Airways operations into United and Delta, incurring costs related to idle aircraft and pilot training during the shift.

Guidance, Outlook, Risks, and Contingencies

• Code-Share Risks: The company is heavily dependent on code-share agreements. Delta Air Lines filed for Chapter 11 bankruptcy in September 2005 and had not yet assumed Mesa's code-share agreement as of the filing date. Delta retains the right to terminate the agreement prior to emerging from bankruptcy. US Airways has notified Mesa of its intent to reduce the number of CRJ aircraft under the code-share agreement in 2006 and 2007.
• Hawaiian Operations: Mesa launched "go!", an independent inter-island Hawaiian airline, in June 2006. Management noted that results from revenue-guarantee contracts offer no guidance for this new independent operation, which faces risks regarding brand recognition, expense control, and competition.
• Legal Proceedings:
  • Hawaiian Airlines: Sued Mesa in February 2006 alleging breach of a confidentiality agreement regarding Hawaiian's bankruptcy. The court denied Hawaiian's request for a preliminary injunction to stop Mesa's ticket sales, but the case is set for trial in 2007.
  • Aloha Airlines: Filed suit in October 2006 alleging below-cost pricing and breach of confidentiality agreements. Mesa has moved to dismiss claims related to pricing based on federal preemption.
• Labor Relations: Approximately 3,000 of 5,200 employees are unionized. The flight attendant contract became amendable in June 2006, and the pilot contract becomes amendable in September 2007. Negotiations are ongoing.
• Liquidity: The company holds $234.3 million in cash, cash equivalents, and marketable securities. However, it faces significant lease obligations totaling approximately $2.3 billion and must secure permanent financing for aircraft currently on interim financing.

Investor Verification Checklist

• Delta Bankruptcy Status: Verify whether Delta Air Lines has assumed or rejected Mesa's code-share agreement in its bankruptcy proceedings, as this impacts 9% of passenger revenue.
• US Airways Fleet Reduction: Confirm the execution of US Airways' plan to reduce CRJ aircraft under the code-share agreement and the financial impact on Mesa's revenue guarantee.
• go! Profitability: Monitor the financial performance of the new independent Hawaiian operation ("go!") to assess if it can achieve profitability without the protection of revenue-guarantee contracts.
• Fuel Cost Exposure: Review the extent to which fuel costs are reimbursed under revenue-guarantee contracts versus the exposure in pro-rate and independent operations.
• Debt Financing: Verify the company's ability to secure permanent financing for aircraft currently held under interim financing arrangements with the manufacturer.
• Legal Outcomes: Track the resolution of litigation with Hawaiian Airlines and Aloha Airlines regarding the inter-island market entry.