Mesa Air Group, Inc.

Thank you for standing by and welcome to Mesa Airlines Q4 and full year fiscal year 2022 conference call. All participants are in a listen-only mode until the question and answer session of today's call. At that time, to ask a question, please press star 1 on your touchtone phone. This call is being recorded. If you have any objections, please disconnect this time. I would now like to turn the call over to Doug Cooper, Head of Investor Relations. Mr. Cooper, you may now begin.

Thank you, Ted, and welcome. everyone to Mesa's earnings conference call for its fiscal fourth quarter and fiscal year ended September 30th, 2022. On the call with me today are Jonathan Orsine, Mesa's Chairman and Chief Executive Officer, Brad Rich, Executive Vice President and Chief Operating Officer, Michael Lotz, President, and Tor Zubek, Chief Financial Officer, and other members of the management team. Following our prepared remarks, there will be a question and answer session for the sell-side analysts. We also want to remind everyone on the call today's discussion contains forward-looking statements that are based on the company's current expectations and are not a guarantee of future performance. There could be significant risks and uncertainties that cause actual results to differ materially from those reflected by the forward-looking statements, including the risk factor discussed in our report on file with the SEC. We undertake no duty to update any forward-looking statements. In comparing results today, we will be adjusting all periods to exclude special items. Please refer to our fiscal fourth quarter earnings release which is available on our Web site for the reconciliation of our non-GAAP measures. With that, I will turn it over to Jonathan for his opening remarks. Jonathan?

Thank you, Doug, and thank you everyone for being with us today. Since we spoke on last quarter's results, several significant transactions have occurred at MESA. Collectively, these new agreements transition our business from American Airlines to United, address the industry-wide pilot shortage and its financial and operational impacts, and create a much stronger liquidity position and balance sheet. Combined, these initiatives have transformed our business. Let's walk through what has been accomplished. As we announced on December 19, as a result of ongoing unprofitable operations due in part to utilization penalties and uncovered increases in our pilot wage structure, we initiated and finalized an agreement to wind down our contract with American Airlines by April 3rd, 2023. Unfortunately, while American initiated dramatic wage increases at their own subsidiaries, they were unwilling to reimburse MESA for similar pay increases at our American Eagle operation, leaving us vulnerable to unprecedented pilot attrition. This led to an untenable situation and required us to take action. Fortunately, based on our strong relationship with United Airlines, combined with our consistent operational performance over many years, United took a different view and quickly stepped in to take over the American CRJ900 flying. Given the industry-wide shortfall in regional jet block hours, United supported higher wages in both our E175 and CRJ900 operations, and intends to increase service to many of the smaller and rural cities that have lost flying due to the pilot shortage. As a result, on December 27th, we finalized a new five-year capacity purchase agreement with United that covers up to 38 of our CHA 900s, depending on the number of 175s we are operating. While there is a very clear business case for United's decision, this deal was made possible as a result of a strong relationship that has developed between United and MESA over the past 30 years. To ensure a smooth transition, our CRJ900 crew and maintenance bases in Phoenix, Dallas, El Paso, and Louisville will remain in place, with an additional CRJ900 crew base to be added in Houston, along with a new pilot base in Denver to expand services to western states. Other incremental crew bases will be potentially added. MESA will continue to utilize all of its pilots and crews in the existing locations through the transition and beyond. In addition to these actions, our new pilot pay scale has had an immediate and significant impact on attrition as well as our ability to attract qualified candidates. We currently have approximately 400 pilots in our training pipeline. Concurrently, United is providing financial support to MESA under two additional agreements that we also finalized on December 27. One, to provide MESA a new 41.2 million liquidity facility, of which 25.5 million will be additional liquidity. And another, to purchase 30 spare engines from MESA for $80 million, generating over 50 million of net cash proceeds. As part of the transaction, United will also receive a 10% equity position in MESA and a seat on the Mesa board. We thank United for their support and we look forward to capitalizing on the substantial demand for regional jet flying together. This is an important reversal momentum for the regional airline industry as Mesa and I will work to restore service to neglected smaller and rural markets, three quarters of which have seen service reductions in the past three years by adding over 100 daily regional jet flights to the United network. We look forward to leveraging our previously announced co-investments with United on new technology and electric aircraft to further address the needs of smaller and congested communities. Moreover, after the transition, Mesa will be the only exclusive regional carrier for United operating large regional jets. We believe our strong relationship with the United will provide significant opportunities in the future as a preferred carrier. In particular, we believe Mesa's participation in the AVA program combined with United's industry-leading growth plan, will provide the most reliable, fastest path for aviators to transition to a major commercial care. Once our operations are fully integrated with United, Mesa will be the most attractive career path in regional aviation for pilots, as well as all of our other employee groups. In the quarter, we also signed a new two-year agreement with our flight attendants. I would also like to note that our operation with DHL was unaffected by the American and UNI agreements, and we continue to maintain a strong relationship with DHL. Additionally, we have completed a number of transactions to strengthen our capital structure. In mid-December, we renegotiated improved terms and conditions with EDC, Export Development Bank Canada, on debt associated with seven next-gen CRJ900 aircraft reducing debt service by approximately $14 million from January 2023 to December 2024. The junior note holder, Mitsubishi, has also agreed to forgive 50% of the outstanding note balance, or approximately $4.2 million, if the notes are fully repaid prior to December 31, 2023. Additionally, we negotiated an agreement with Raspro, a Canadian special purpose finance company, on our leases of 15 CRJ900 aircraft which reduces the effect of purchase prices at or prior to March 2024 lease termination by approximately $25 million. Concurrently, MESA plans on closing on the sales of the remaining eight CRJ550s denited in January 2023 and 11 surplus CRJ900s to a third party, resulting in net cash proceeds of $16.2 million. These sales are expected to reduce Mesa's US Treasury debt by approximately $65 million and reduce annual interest expense by approximately 4.5 million at current rates. With that, I will hand over to Brad Rich to go over more of the details of an update on our operational performance this quarter.

Thank you, Jonathan, and good afternoon to everyone. I'd like to start by reviewing our quarterly operating results. In the September quarter, we flew 56,533 block hours, 11% below the June 2022 quarter, in line with our forecast on last quarter's call. Our December quarter block hours are projected to be 52,000, roughly 9% below the September quarter. For the March quarter, we are currently forecasting 53,000 block hours, a slight increase over the December quarter. Consistent with the challenges throughout the regional industry, our block-hour production has been limited due to the pilot shortage. As mentioned previously, attrition has come down materially and we are filling our classes into the future. Our pilot training production is a major focus and we continue to expand our capabilities with an additional EJET simulator coming in the spring of 2023 and additional instructors in both the EJET and CRJ fleets. In addition to our own hiring, we have contracted with CAE to provide additional support for our training efforts. We are focusing on our transition out of American and working cooperatively with United in making preparations for facilities, crews, and maintenance. We expect to operate our current American schedule through February 28th or approximately 24 lines of flying. From March 1st through April 3rd, we will reduce the schedule by 50% and our operations with American will cease on April 3rd. Beginning March 1st, we will begin operating nine lines for United and expect to have 24 lines operating by May of 2023. As part of the transition agreement with United, as part of the transition agreement, United will pay the expenses to reconfigure and rebrand the CRJ900 aircraft. As we transition our CRJ900 flying to United, we look forward to maintaining the same level of schedule integrity associated with our ERJ fleet. With that, I'd now like to turn the call over to Torque to walk through our financial performance.

Great. Thank you, Brad. And thank you to everyone on the call today and for your patience as we work to release our quarterly and fiscal year results. As you can see, the delay was due to a number of transactions that were being finalized that meaningfully restructure our flying agreements, as well as our debt and lease obligations. As Jonathan has already covered most of the transactions, I'd like to just touch on a few items and summarize our expectations. First, for performance in the first quarter, revenue in the fourth quarter of fiscal year 2022 was $125.6 million, a decrease of $5.1 million, or a negative 3.9%, from $130.8 million for Q4 2021. Our contract revenue fell by $5.3 million year-over-year. Pass-through and other revenue remained relatively flat to last year, rising 1% primarily due to pass-through maintenance expense. And as a reminder, the pass-through maintenance expense has no P&L impact. Mesa's Q4 2022 results include, per GAAP, the deferral of $1.3 million versus the recognition of $1.3 million of previously deferred revenue in Q4 2021. The remaining deferred revenue balance of $24.1 million will be recognized as flights are completed over the remaining terms of the contract. On the expense side, Mesa's overall operating expenses for Q4 2022 were $266.8 million, up $141.1 million versus Q4 2021. This increase was driven by $132.3 million expense for impaired assets related to the American Asset Group. The relatively short duration of the remaining contract with American Airlines and the relative uncertainty around longer-term utilization of CRJ 900 fleet and supporting assets. General and administrative expenses of $12.4 million, primarily driven by a one-time tax adjustment of $7.1 million. Maintenance expenses continued at below normal levels as we passed the high number of engine overhauls and heavy fee checks that were deferred at the beginning of COVID. Maintenance cost was $45.9 million in Q4 2022, down $15.1 million. or $24.8 million versus Q4 2021. On an adjusted basis, MESA reported a pre-tax loss of $16.4 million for Q4 2022 compared to a pre-tax loss of $3.1 million for Q4 2021. The year-over-year decrease of $13.3 million was primarily due to lower block-hour production and the net impact of the PSP program. It's important to note that the adjusted pre-tax loss for Q4 excludes $132.3 million impairment loss primarily related to the group of assets that are supporting the American CPA. Excluding this item adjusted, a net loss is $13.5 million or $0.37 per share compared to a net loss of $2.1 million or $0.06 per share a year ago. For the fourth quarter fiscal year 2022, we reported a net loss of $115.6 million or $3.18 per diluted share compared to a net loss of $7.5 million or $0.21 per diluted share for Q4 2021. Let me turn to cash and liquidity. Cash for the quarter, excluding restricted cash, increased by $3.3 million from the prior quarter, June 30, 2022, to $57.7 million. Based on United funding the $25.5 million loan this week, our projected December 31st cash balance is $55 million. This excludes any of the proceeds from the sales that are not expected to close until the new calendar year. Total debt at the end of the quarter was $599.7 million, down $36.3 million from the prior quarter. During the quarter, we made scheduled debt payments of $42.9 million. Most importantly, combined, our sales transactions will reduce debt by $84 million by as early as March 2023. We also have $80 million of scheduled principal payments in 2023, resulting in projected end of fiscal year 23 debt of approximately $435 million. We're looking to full year 2023 given the major developments at Mesa that we've discussed today. We will not be providing specific financial guidance at this time other than the block hours that Brad discussed earlier. With that, I'd like to now turn it back over to Jonathan for closing remarks.

Thank you, Tor. In summary, 2022 was a challenging year for the regional industry and for Mesa in particular. But we made many important strides in the past few months towards turning our business around. We reached major operational financial agreements with United. We shed our loss-making business with American. We implemented a new pay scale for our employees and seized opportunity to shore up our balance sheet through significant reduction in debt and increases in cash. To end this call, I'd like to again thank United for its continued support over the past three decades, as well as our other shareholders, stakeholders, such as the US Treasury Department, Export Development Canada, RASPRO, and Mitsubishi, as well as the assistance of Sidley Austin representing United and FTI representing Mesa. We are especially thankful for the efforts of all our employees towards helping us rebuild and optimize our operations, setting Mesa up for future success. At this point, operator, please open up the call as I'd like to field any questions that analysts may have.

The phone lines are now open for questions. If you would like to ask a question over the phone, please press Star 1 and record your name. If you'd like to withdraw your question, press Star 2. The first question we have in the queue is from Michael Linenberg with Deutsche Bank. Your line is now open.

Michael Linenberg Hi, good afternoon. This is actually Shannon Doherty on for Mike. Just a couple of quick ones here. You know, how quickly can you guys stabilize the operation and transition from American to United? And once finalized, how many airplanes will you expect to be flying with United in total?

Hi, this is Jonathan. You know, our plan is to begin the transition basically in March and be done by April, mid of April. And we're going to be operating the CRJ-900, you know, for as long as we still have CRJ, excuse me, the EJET-175, you know, in the training cycle with pilots. We don't know when that would be finalized, but we do have 80 aircraft that would be in the American operation and that's just, excuse me, in the United operation, pardon me. And that would just be, you know, our first, you know, step one of the, you know, going forward in the relationship with United.

That's helpful. You know, maybe, Jonathan, can you explain any implications that may exist due to scope limitations? You know, from my understanding, United doesn't have any more room for 76-seaters in its fleet. So how are you exactly moving the CRGs over without violating scope restrictions? Thanks for taking my question.

Yeah, no, there's a misunderstanding there. I mean, no one's going to violate a scope restriction. It's just that there are aircraft parked throughout the United system, you know, our own, for example, where there are aircraft that have been pulled out of the CPA and are not counted towards that scope. And that's due to the lack of pilots as a result of the pilot shortage. And we're just basically filling the breach as ourselves and others spool up those aircraft. And it's obviously taking time. Training is not something that happens in the short term. And that's why having these aircraft move over are very valuable to fill that gap that exists today.

Thank you. Our next question in the queue is from Savi Flight with Raymond James. Your line is now open.

Hey, good afternoon. I was curious. I know you're not kind of giving commentary on earnings kind of guidance, but I was curious as I was thinking about both kind of earnings and then kind of cash flow, would this transition kind of, how should we think about, like, what changes in the cadence that you saw here in the fourth quarter of the fiscal year versus what you'll see going forward? It seems like you're just basically replacing some of the American flying with United flying, so all those equals. Should we see kind of a similar trend until you can get, you know, the pilot or the captain supply up to levels where you can start increasing utilization?

No, and I'll tell you why. I mean, primarily, A couple of things that have changed the dynamics at first. The United Flying, I mean, obviously there will be a transition period, but the United Flying on a run rate basis will not lose money. I mean, we're losing roughly $5 million a month in the American operation, which, you know, based on the numbers that we have and where we're going to get, you know, how we view the United contract, will not be loss-making, will be, in fact, profitable. In addition, we are shedding quite a bit of debt through this process, and, you know, just the savings alone off U.S. Treasury debt, I believe, is, you know, $5 million, $6 million a year. You know, that also, you know, obviously will help add both benefit cash flow and earnings. But, you know, I think it's fair to say that there is a transition period that's going to require some time, and there are training expenses which are still extremely high. and it's going to take some time to work through that. But, again, shedding the loss-making operations, like I said, which was about $5 million a month, is actually pretty significant. And, you know, remember that as part of the transaction, which really was the heart and soul of the transaction, is that United has agreed to pay the same wage rates that we offered the, you know, that we're offering that United throughout the system as well to the American, you know, the former American pilots that will now be flying on behalf of United. I mean, that is, you know, singularly the biggest reason that this deal moved forward the way it did. And we're just, you know, very pleased and thankful that United has seen, you know, obviously some value for themselves as well to see this additional flying being done as we head into March and the summer of 2023. So we are focusing solely on operational performance in terms of a successful transition. And moving forward, I think it's fair to say that we believe the numbers will take care of themselves.

I appreciate that, Colin. That makes sense, Jonathan. Thanks. And if I might, on the kind of attrition side, you said you just kind of slowed down. This is a bit of a question on what your views are and obviously not something you'll see yet is You saw the Spirit TA that, you know, put a fairly big increase, and now that would move kind of the pay rates, again, away from regional airline pay. Is there a risk that you'll start to see attrition pick up again after, you know, more ULCCs start to reflect that level of pay, or just any views on how kind of the pilot dynamic moves forward in the industry?

I absolutely think that there could be an impact. I think pilots are really good with numbers, and I think most of them will realize that the proposition that Mesa offers coming here with rates maybe a little bit lower than those new rates, but with the ability to move on to United in a very short period of time, that's not just a, you know, a crapshoot, but actually part of their agreement that we will be moving people to United on a specific schedule. I think anyone that looks at that over the long term, particularly over the term of a career, there's no doubt that they are going to be far further ahead by coming to MESA and transitioning to United. And I also think it's fair to say that there are strategic reasons why United does not want us to lose pilots to the ULCCs. and does not feel that this should be a farm team for the ULCC. And frankly, we'll take action if in fact that becomes, you know, the future reality. I don't think that we would be sitting idly by and allowing that to happen. So United has acted very decisively in this particular circumstance, and I see no reason why they won't continue to act decisively to ensure that there's a pilot flow that goes from Mesa and into United. I mean, United has now literally the greatest growth plans in the history of commercial aviation. You know, I heard that in the past Ryanair had been one of the fastest-growing airlines, and, you know, having some familiarity, what they did was remarkable. They put 52 airplanes on in one year. United is looking at years in the future of double that. So there is a big demand for pilots. I think United views Mesa as their farm team, and we intend to do everything we can to see that happen. And I don't think anyone intends to let the low-cost carriers get in the way of that. So we'll do what it takes, and I think United would be supportive of that.

I appreciate the thoughts. I'll get back on the queue. Thank you.

The next question in the queue is from Helene Becker with Cal, and your line is now open.

Helene Becker Thanks very much, Operator. Hi, everybody, and thank you very much for the time. Just a couple of questions. So, Jonathan, I noticed in the 10-K the auditors did not give you a qualified opinion. Is that just because all the liquidity that's coming in and they are comfortable that there are no issues going forward?

Yeah, I think that, you know, the auditors looked at the breadth of the agreements that were put in place, whether it was the new flag agreement with United eliminating the losses, the pay down of the debt with the U.S. Treasury, the enhanced, you know, agreement that we had with the other lessors and credit debtors. I think a big part of it was undoubtedly the sale of 30 of our 51 engines. for proceeds that will net over, you know, well, $50 million we think is a conservative estimate and the pay down between the engines and the aircraft that will now finalize the sale with United and the 11 additional aircraft. I mean, we're talking about a lot of debt coming off our balance sheet and I think that all those things combined is why the going concern issue, you know, would go by the wayside because I think from their perspective, seeing what restructuring was done, I think is pretty significant. And again, I can't overemphasize, we went on a very, very distinct path five or so years ago where we decided that we were going to go into effectively the engine business and started buying engines. We own a lot of engines. Some of those engines are now paid off or close to being paid off. And, you know, as I said, we did sell 30 engines tonight out of the 51 engines. And on those 30 engines, you can see the proceeds. And I think that, you know, we probably will be looking at additional sales. What's that?

We have 20 more.

Yeah, we have 20 more engines to sell. And I think that all these are all access to our requirements now. So I think that, you know, we continue to see opportunities for enhanced liquidity.

That's very helpful. Is there... Just one question unrelated to everything we've been talking about. What about the European operation? Is that moving forward? Is that going on hold? How are you thinking about that?

Well, you know, the European operation is very interesting because, you know, initially we thought that it was a way for us to do something with excess CRJs. We've now proven that we can actually sell the CRJs here and be able to not only pay off our debt but maybe generate a little bit of cash. But now the opportunity there has been there is clearly demand for regional flying there. And I think that, you know, having that foothold there and being able to put CRJs into service there I think ultimately will be very successful. They do not have the same pilot issues, which I think makes sense. And I also think it's fair to say that, you know, we take this green technology seriously. And it may be down the road, but it's still down the road. And I think given what's going on in Europe and to the extent that they move a little bit quicker in the environmental issue and the fact that just demographically that, you know, the geography would be easier to navigate with the early electric aircraft, we think this also could be a great platform to launch some of these electric and new technology aircraft as well. So I think, you know, it obviously plays a role. It may be small now, but, you know, the future comes and, You know, when I look back and, Helene, you know, I mean, when I first joined Mesa, we were flying 15 passenger unpressurized turbines on 130-mile stage lengths. We're now flying 1,000-mile, you know, stage lengths in 76 passenger jets. The future comes faster than you think. So I think it's all part of a big strategy, and I think that the European operation will continue to be an important part of our, you know, moving forward.

That's very helpful. Thanks, Jonathan.

The next question, the Q is from Savi Fife with Raymond James. Your line is now open.

Hey, thanks for the follow-up. Just on the unencumbered assets, there's a lot of moving parts here. Are there any other unencumbered assets other than the kind of the 20 engines that you have to sell? And just tied to that a little bit, on the CRJ900 suites, What's the white tail risk there? Because I'm guessing, again, the United contract doesn't increase your overall flying, so the funds from there really cover your E175 fleet. So I was kind of curious what the CRJ900 tail risk is.

Well, I mean, you know, first off, I think we should clarify. Some of the assets are unencumbered or close to being unencumbered on the engines, but most of the engines do have debt. It's just that, you know, we basically pay down the debt, you know, as a rule of thumb, twice as fast as they depreciate. So by the time we finish paying off the debt on those engines, which is five years, the engines are worth at least half of what we paid for them, and there's no debt, and generally a little bit more because there's residual value in the cores of the engines. On the other aircraft, I mean, obviously it will be different tail by tail, but, you know, the 11 aircraft that we sold, I think it's kind of important to note that those aircraft were sold had literally – zero engine time remaining on them. So, you know, potentially the worst of our aircraft, and we're still able to, you know, pay off the debt associated with those aircraft and actually generate a little bit of cash. So I think we feel pretty good about where we stand on the CRJ fleet, particularly given the environment being so bad right now. But, again, all that debt is associated primarily with the government, which is interest only, and gives us some time to work our way through those. And we did just negotiate, you know, these new transactions with RASPRO and with EDC. And then, again, that also gives us some time to sort of work our way through. And, you know, with the reduction, for example, in RASPRO, I think we feel pretty confident that when those leases terminate, we're not going to be looking at a significant amount of tail risk in terms of the value of those aircraft at that time.

That's helpful. And just thinking longer term, you know, the captain supply issue or pilot supply issue is not going to last forever. So what level, is there kind of a new normal of profitability if you kind of get back to the levels that you were kind of utilizing the fleet previously? Is there kind of any insights on that kind of the new normal?

Well, I think that, you know, we basically have an agreement with United that if we were flying, you know, the number of hours that we generally projected, I think our level of profit would be roughly the same because they have, in fact, you know, increased the payments to us by the amount of the new labor costs. You know, to give you an idea, I was talking to Mike in just a nutshell You know, we've made a lot of improvements and yet, you know, again, we're still going to have to work hard to get the company back to profitability. You know, when you look at the big picture, you know, two years ago we flew 38,000 block hours a month and last month we flew, you know, something under 16,000. So you can see there's a lot of room for us to go here, a lot of pilots to hire, a lot of pilots to train, a transition to go through for us to return to profitability. But clearly there's a pathway. there's liquidity to support that. And, you know, most importantly, I will say we have United who clearly has made demonstrated that we're an important character to them going forward and I think will be there to help us, you know, through this transition.

Got it. I appreciate it. Thank you.

And I'm showing no further questions at this time.

Okay. Well, thank you, Albert. Let me just close in this and I think it's really important, you know, that people appreciate Look, you know, we are now having the opportunity to really focus on these operations and focus on our partnership with United. United is committed to growing their company. It will help us grow our company. They're committed to regional aviation. They too have witnessed the, you know, just dramatic cutbacks throughout regional aviation in terms of rural cities. I know that the leadership at United really would like to see that improved and see things turn around. Mesa has always been a rural aviation carrier. We'd love to be a part of that. United is also committed to green technology and doing the right thing for the planet. We've co-invested with them now on a number of deals. I think that we would like to think that we could be at the forefront along with United in terms of the implementation of that technology. You know, we have a long road to hoe for sure, but I can't tell you how strongly all of us feel that this is just a great step for Mesa, you know, hopefully a great step for United as well, and that, you know, we feel that our people will clearly be the beneficiaries of this with enhanced security, job security, enhanced opportunity, the AVA program. I mean, I don't think there's going to be a better place to go than Mesa Airlines for folks looking to get into the aviation industry. So overall, we're very enthusiastic about it. We are very thankful for all the parties that helped make this happen, and we look forward to seeing some of that value reflected back to our shareholders as well. So thank you very much, and have a great, happy new year.

This concludes today's call. Thank you for your participation.