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Edited Transcript of MESAQ.PK^C11 earnings conference call or presentation 11-Dec-19 9:30pm GMT

Q4 2019 Mesa Air Group Inc Earnings Call

Phoenix Jan 3, 2020 (Thomson StreetEvents) -- Edited Transcript of Mesa Air Group Inc earnings conference call or presentation Wednesday, December 11, 2019 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian S. Gillman

Mesa Air Group, Inc. - Executive VP, General Counsel & Secretary

* Jonathan G. Ornstein

Mesa Air Group, Inc. - Chairman & CEO

* Michael J. Lotz

Mesa Air Group, Inc. - President & CFO

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Conference Call Participants

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* Conor T. Cunningham

Cowen and Company, LLC, Research Division - Associate

* Kate Lyness;Deutsche Bank;Research Associate

* Matthew Burke Roberts

Raymond James & Associates, Inc., Research Division - Senior Research Associate

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Presentation

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Operator [1]

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Welcome, and thank you for standing by. (Operator Instructions) This call is being recorded. (Operator Instructions) Now I will turn the meeting over to your host, Jonathan Ornstein. You may begin.

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [2]

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Thank you, operator. Thank you, everyone, for joining us on the call today after hours. We greatly appreciate your interest. As the operator indicated, this is Jonathan Ornstein. I'm the Chairman and Chief Executive Officer of Mesa Airlines. On the call with me today will be Mike Lotz, our President and Chief Financial Officer; Brian Gillman, our Executive VP and General Counsel, and Darren Zapfe, our Vice President of Finance. Unfortunately, Brad Rich, our Chief Operating Officer, is unable to join us as he had to be on a flight to attend his daughter's college graduation.

Okay. With that, I'd like to ask Brian to open up with our forward-looking statement.

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Brian S. Gillman, Mesa Air Group, Inc. - Executive VP, General Counsel & Secretary [3]

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Thanks, Jonathan. Before the presentation and the comments begin, Mesa would like to remind you that some of the statements in response to your questions in this conference call may include forward-looking statements. As such, they are subject to future events and uncertainties that could also affect our results to differ materially from those statements. Also, please note the company undertakes no obligation to update or revise these forward-looking statements. Any forward-looking statements should be considered in conjunction with the cautionary statements in our press release and the risk factors included in our filings with the SEC, which Mesa encourages you to read. In addition, please refer to our press release in the Investors section of Mesa's website to find additional disclosure and reconciliations of non-GAAP financial measures that will be used on today's call.

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [4]

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Okay. Thank you, Brian. Well, I think it's important that we start in giving you a United update. We certainly are pleased to have our new capacity purchase agreement put into place. We know it took a lot longer than any of us anticipated. We would like to thank United. It was a complicated transaction, but we believe it was well worth the wait. I am delighted not to have to tell you it's going to be in 2 more weeks.

We have plenty new Embraer 175 aircraft for a 12-year term. These aircraft will be owned by Mesa. In addition, we extended the term of 42 United-owned 175s. We believe the contract will give us improved profitability and reliability on the new Embraer 175s. In addition, we agreed to lease our CRJ700s for a period of 7 years to another operator. We believe this is significantly lower risk and equal or potentially higher margins on leases versus actually operating the CRJ700s in the CRJ550 configuration.

Mesa will be the largest operator of Embraer 175s for United at 80 aircraft. We greatly appreciate their confidence in us. We will be a single fleet type for our United operations, making us a more attractive growth vehicle. We believe the new contract is a strong vote of confidence from United.

On American. As you know, there have been a lot of moving pieces on the American fleet, spares, damaged aircraft, removed aircraft, et cetera, so first, I'd like to recap exactly where we are on the American fleet. We began with 64 aircraft in our CPA. On April 1, 2019, we voluntarily agreed to remove 2 aircraft, splitting the cost with American. On November 2, 2019, 2 additional aircraft were removed under the terms of our amended CPA. On January 2020, 1 additional aircraft will be removed under the terms of the amended CPA. So in January 2020, we will have 59 aircraft under our CPA, of which 3 are operational spares, and we will have 5 unassigned aircraft. One important item to note, even after these fleet changes, our block hour estimates for 2020 are in line with 2019, slightly lower at American and slightly higher at United. Additionally, American has the right to remove up to a maximum of 3 more aircraft based on operational performance.

I'm going to go further into operational performance in a minute, but we have seen significant operational improvement since November 2, coinciding with the access to additional aircraft. I'd like to take a moment now to update you on our efforts in cargo. We continue to remain optimistic on entering into the cargo business in 2020. We believe cargo represents a significant long-term growth opportunity. Given the nature of our current business and our cost structure makes us particularly well suited to enter the ACMI or CMI Cargo business. We believe 1 of the benefits is that it's no conflict with our existing business. In fact, we believe the opportunity to fly larger-gauge aircraft will improve our ability to both recruit and retain pilots, which is of critical importance to our major airline partners.

Other industry opportunities as we look into 2020 include the following: scope relief at United; while this has been long discussed, we believe that United is probably best positioned to achieve scope relief. We also are looking at a potential opportunity to down-gauge the American CRJ900s to 65 seats and to potentially provide some of the backfill with larger regional jets. We believe the CRJ900s operated by Mesa are probably the best option for 65 seat aircraft. We have a very enthusiastic, energized and highly efficient workforce ready to take on additional opportunities.

Unfortunately, Brad is not here. He wants me to send his apologies; obviously, he has an important personal issue matter with a daughter, which is a very good thing. So I'm going to touch on some of the operational issues as well. Most importantly, we can start with American update. While we have recently experienced significant improvement, as I mentioned, and we mentioned in the press release, our fourth quarter American performance still did not meet our expectations. The primary reason can be attributed to the continued lack of available spares through the quarter due to extended heavy checks and multiple aircraft ground damage events. On a positive note, however, since gaining access to additional aircraft, although not our full complement, the November controllable completion factor was 99.7%. And for the first 10 days of December, we have not had a single controllable cancel. Since joining Mesa, Brad Rich, and our new Senior VP of Operations, Brad Holt, has worked closely with American and have instituted a number of initiatives that we believe will allow us to continue to see these improved results.

United update. Since October 1, our United Express operation has produced an outstanding 99.99% controllable completion factor and in the month of November, Mesa led all United Express operators in on-time performance. Again, I'd like to thank all of our people for doing a truly remarkable job on both the American and United side of our business.

Other operational items of importance. We are pleased to report an increase of 119 line pilots year-over-year; we remain confident in our ability to both hire, retain, require pilots in order to produce the utilization and reliability expected by our partners. We have significantly improved our pilot training footprint and substantially reduced our training backlog over the last 90 days. We've also had success hiring additional mechanics to support the operation, which has become more challenging. Our mechanic head count has increased by 66 or almost 23% year-over-year. However, it's important to note that industry conditions make mechanic high retention more challenging and an area of continued focus. In the area of maintenance, we had issues with a heavy maintenance vendor, which we discussed on last quarter call, and we have subsequently replaced the vendor with alternative providers.

I'd like to now turn it over to Mike Lotz to walk through our financial performance.

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Michael J. Lotz, Mesa Air Group, Inc. - President & CFO [5]

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Thanks, Jonathan. For the fourth quarter, we reported pretax income of $17.1 million. This compares to pretax income of $26.6 million for the same quarter last year. The quarter-over-quarter variance is due primarily to the timing of scheduled heavy maintenance and airframe maintenance of approximately $9 million. Additionally, for the quarter, we reported $4.8 million of income tax expense for net income of $12.2 million or $0.35 per share. Excluding special items, our adjusted net income was $12.7 million or $0.36 per share. I'd also like to point out, as Jonathan touched on cargo during the quarter, we did invest and expense about $1 million in the cargo operation. Excluding this cargo expense, we would have been at around $0.38 per share.

Just a quick note also on our income tax expense, although we do reflect income tax expense of $4.8 million for accounting purposes, we will not pay any cash taxes as we still have a significant $475 million in NOLs.

For 2019 overall, we showed significant improvement over 2018. Year-over-year, we saw improvements in virtually every area. Adjusted pretax income was up 78% from $43 million to $76 million. Adjusted EBITDA was up 27%. Adjusted EBITDAR was up 12%. Block hours were up 12% on essentially the same fleet by increasing the utilization of the aircraft. Contract revenue was up 7%, $43.5 million, up from $639 million last year. Pretax margins increased 5 points from 6% to 11%. Rent was reduced by $16 million, which was offset by depreciation of approximately $13 million as a result of buying 10 aircraft, which we had previously leased. Interest was down $4 million as we refinanced high-cost debt and repaid our secured credit facility. Pilot expenses were down per block hour, a little over 9% from $509 a block hour down to $462, and as a percentage of contract revenue from 33% to 31%. We are expecting the block hour rate to stay at this level until Q4 2020, getting down to around the $440 range or another 5%, and that will be primarily driven by pilot training efficiencies.

And as I previously pointed out, we invested approximately $1 million in potential cargo operations, which was expensed in Q4, and we will continue to see in 2020. So all in all, given some of the operational challenges that were clearly outside of our control, we believe we worked through these issues reasonably well and minimized the impact on profitability. As we disclosed in our press release earlier today, we have provided some additional forward-looking guidance for earnings per share for 2020. We're looking at a range of $1.50 to $1.80 per share. And in 2021, from $1.90 to $2.30. For block hours, we're expecting 2020 block hours to be about the same as 2019. And again, that's with less aircraft than we had in 2019. For scheduled heavy engine and airframe maintenance, 2020 guidance that we provided will be $8 million to $10 million higher than 2019. We also provided this information on a quarter-by-quarter basis.

So overall, at a high level, for 2020, it's going to be slightly better than 2019. In our 2020 estimates, we've included roughly $3 million of additional expenses related to the cargo operation and almost $5 million, which will be associated with transitioning pilots from the CRJ700 to the E175. That number, obviously, will be dependent upon how many pilots transfer between the fleets. Combined, these investments represent almost $0.17 per share for 2020.

On the cash and liquidity side, we ended the quarter with $68.8 million in cash. Total debt on the balance sheet at year-end was $843 million. That's primarily aircraft and engine debt, about $750 million in aircraft and around $90 million in engine. That's down $72 million from the $915 million as of September 2018. During the year, we paid $156 million in principal payments, which was offset by $70 million in debt that we added with the aircraft lease buyout and $11 million of spare engine financings. For 2020, we have scheduled principal payments of $175 million.

CapEx for 2020 and 2022 will obviously include the 20 new E175s for United. That will be approximately $420 million to $470 million that will be split probably 50-50 between 2020 and 2021, and we were planning to finance most, if not all, of the purchase price. Additionally, for 2020 and 2021, we plan to purchase 20 to 25 engines to support the lease CRJ700s and the CRJ900 fleet at American. This will be approximately $100 million, split roughly 50-50 per year between 2020 and 2021. On the engines, we are planning to finance 100% of the purchase price, which we have done in the past.

On the financing, refinancing side, as a result of our new United CPA, we will lease 20 CRJ700s to another operator for 7 years. This will allow us the potential to finance 5 unencumbered CRJ aircraft and refinance the other 13 CRJ7 aircraft over an extended period of time at lower rates.

Lastly, on cash, we still have our secured credit facility of $35 million, which was extended through 2022 and is currently untapped.

I'd like to turn it now back over to Jonathan.

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [6]

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Okay, Mike, thank you for the financial round up. And at this point, operator, we'd be happy to field any questions that come from any of the listeners.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question came from the line of Michael.

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Kate Lyness;Deutsche Bank;Research Associate, [2]

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This is Kate Lyness on for Mike Linenberg. I was just wondering if you could maybe go into a little bit more detail, please, about like some of the drivers underlying your 2021 EPS guide, block hour growth, the new cargo business, any of that?

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [3]

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Well, let's start with cargo. To clarify, Mike talked a little bit about the fact that we'd have additional investment in the cargo business. These are pre-operating startup expenses and then some training expense as we begin to train more pilots to take on all of the aircraft. We expect that to be approximately $3 million for the year. So that's 1 potential driver.

On the block hours, basically, we have an estimate based on past, and we have spoken with our partners about what our capabilities are, what their expectations are. And I think the block hour number, I think, at this point, we're getting pretty good at being able to project going forward. In terms of some of the other numbers, again, the big variable always is maintenance for us. That's something, again, we have decent visibility. There's often some issues regarding timing, but we think this is 1 area where, I guess as I said, has the biggest impact on our quarterly earnings. Did you want to add anything, Mike?

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Michael J. Lotz, Mesa Air Group, Inc. - President & CFO [4]

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No. So -- and also for 2021, we are expecting that our transition will finish up in the early first quarter of 2021; most of that will be behind us. So I think we will see a pretty big benefit from our flight operations expense as we kind of normalize for not having any growth. That's given the assumption we don't have any additional growth between now and 2021.

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [5]

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Yes, there's a fair amount of certainty that the newer aircraft will provide us with higher levels of profitability coming out of older aircraft and into new aircraft, which will be covered under warranty for at least the first 4-year period. So that is some of the reasons why we feel confident and in terms how things continue to improve into 2020 and 2021.

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Operator [6]

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Our next speaker is -- came from the line of Bobby.

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Matthew Burke Roberts, Raymond James & Associates, Inc., Research Division - Senior Research Associate [7]

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Maybe that was for Savi? Operator, can you hear me? This is Matt for Savi.

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [8]

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Yes. Hey, Matt, sure.

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Matthew Burke Roberts, Raymond James & Associates, Inc., Research Division - Senior Research Associate [9]

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First, congrats on the United deal; that was great to see. Moving along now from that, could you talk a little bit about the maintenance, your expectations moving into 2021? I know you guys laid out by quarter for 2020, but maybe some of the puts and takes beyond that?

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [10]

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Yes. I mean we -- right now, we don't have that much visibility into the 2021 timing, so that's why we haven't any -- provided any quarterly guidance, but we expect 2021 to be pretty consistent quarter-over-quarter.

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Matthew Burke Roberts, Raymond James & Associates, Inc., Research Division - Senior Research Associate [11]

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Okay. And then in regards to the -- basically transitioning the CRJ700s to the E175s. You all have maintained your pilot hiring and training at pretty high levels for longer than previously anticipated, based on prior calls. So how has that really helped with the transition of the CRJ700 to the E175?

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [12]

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Okay. So I think 1 of the things that we have found to be very important, and I'll go back in history a little bit, when we began Embraer E175 program, we knew how important this was to United, and we over-hired pretty significantly. Obviously, times have changed a little bit, so it's become more difficult. But we knew that when we move the 700s over, some of the pilots will choose to stay, which will be helpful on the American side for sure, that we will have more CRJ-qualified pilots. And in order to prepare for the backfill, we've begun hiring, and we do have, not a huge excess, but we do have a certain number of surplus E-jet pilots to help when that backfill occurs because all those numbers, those planes are coming in pretty quickly, 2 and 3 a month, and so we just need to be prepared. The biggest piece of it is, we really want to continue to demonstrate to United that we can operate at the levels that they expect because we feel that there, in fact, will be future growth, whether that's coming from scope relief or contracts that come due. We think we are extremely well positioned moving forward.

And 1 of the points that I'd like to make and why we're well positioned, Mesa has a reputation for low cost. I think that it's important to note that a big reason why we have low cost is because we have been growing consistently over the last 6 or 7 years, and our workforce, compared to other regional airlines, is in fact, junior. A lot of our employees are 1-, 2- and 3-year employees. And because you're in an industry where wages are based on seniority to a large degree, we have a built-in benefit that I think it will be difficult, if not impossible, for another carrier to catch us in terms of cost, given the level of what we call juniority at Mesa right now.

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Matthew Burke Roberts, Raymond James & Associates, Inc., Research Division - Senior Research Associate [13]

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Okay. And if I can sneak in another one and talk about on the American side. Now you've certainly made a lot of good leadership hires this year. So could you talk about some of the changes you've made, specifically the results you've seen from those changes and how you feel about it going forward? And then in that regard, are there any key measurement dates around that American deal where we could see if either the current strategy is succeeding or just kind of when the benchmarks are for those periods?

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [14]

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Sure. Well, there's been a number of things that we've done, not the least of which has been to get our spare count to a level that we think we need, given the age of our fleet. I mean our average aircraft in the American fleet is almost 14 years old right now. So when we signed the original contract, we had 3 spares. Three spares is probably fine, 1 for every 20, but with the fleet getting older, I think we both, American and ourselves, came to conclude that was best for us to have additional spares. We see the benefit of that. And again, we've never had the opportunity to operate with a full complement of spares since some of these aircraft came out, because of ground damage in these extended C-checks, but we can already see what we think are pretty good results in terms of completion rate. We're now focusing also on on-time performance, which we think will also be helped significantly these spares come in.

One of the big areas that we spent -- have done a lot on have been in maintenance staffing, where we have, in fact, increased maintenance staffing as we mentioned in the call, almost 23%; a large part of that went into the American staffing. We also had the benefit now, which is something new to us having a hanger in Dallas, in our hub, which is something we had wanted literally since we start operating there. And we are very fortunate we were able to find a facility to do that. We think that will have a big benefit. We've been able to further staff and build up our other maintenance base in Texas and El Paso, which has been very successful. So all these things, I think are going to inure to our benefit over time, and the greatest of which being the additional spare aircraft, for sure. Another piece of that, as part of our agreement with American, they understood our requirements in terms of maintenance touch time and the number of aircraft that come into maintenance. So that doesn't fluctuate as much as it has in the past. All those things we think are beneficial and the very fact, when you're talking about over 300 departures a day that, since this last month, I know it's only 11 days, but we haven't had a cancel. And last month, again, we ran 99 point, I think, 7 percent, that's the best level in quite some time. So I think we're already beginning to see the benefit of some of those initiatives that we worked so hard and been -- actually been very helpful that American has been involved along the way. So I think all those things will start to -- you'll see this continued level of performance.

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Operator [15]

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(Operator Instructions) Our next question came from the line of Conor.

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Conor T. Cunningham, Cowen and Company, LLC, Research Division - Associate [16]

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This is Conor Cunningham from Cowen. Just on the leased aircraft, can you just give a little color on economics? I know you talked about them potentially being a little bit better. Just curious if you could give any color there? And also, is this like a line item where you would expect to have further growth over the next couple of years? Like, could we potentially see you guys going out there and being a bigger dry lessor on the regional side?

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [17]

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Okay. On the 700s, which would, in fact, for United's purposes where they're down-gauging those aircraft to 50 seats and being able to put first class, the 20 we have are the only 20 aircraft that would be suitable for that program. The CRJ900s, besides the fact they're in service with American, they're too heavy to be put into that program. In terms of the relative profitability, as you can imagine, in order to fly the 550s in 50 seats, United needed to see some fairly significant reduction in the expense associated with those aircraft in terms of their operation. It was our view that the lease terms for the aircraft would be more attractive to us ultimately and significantly less risk in terms of operation, particularly given the 20 additional aircraft on the E-jets, on the pilot side, that we just were better off leasing the aircraft.

You do -- as we mentioned, there are 5 aircraft that we currently have that are unencumbered, for example, and a number of the aircraft will in fact get paid off over time, making that transaction even more attractive. I think that in terms of the overall financials, a large part will depend on our ability to replace -- to do engine overhauls and how that works. But again, having been the first in the chute, in regards to these big engines on the larger regional jets as the launch customer for the CRJ900, I think we have a very good handle what our expenses are going to be, and we feel confident that the lease transaction will, in fact, be a better transaction than operating the aircraft on our own in the 50-seat configuration.

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Conor T. Cunningham, Cowen and Company, LLC, Research Division - Associate [18]

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Okay. But it's not -- sorry, go ahead...

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [19]

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I'm not saying -- in terms of the other aircraft, we have withdrawn a number of aircraft out of the American system. At this point, our plan is to leave them as spares. One of the things that this brings up, to point out is, we are paying down a significant amount of debt. We have -- some of those aircraft, by the time on the American transaction is completed, that -- and this doesn't even assume an extension, but we're going to own outright or nearly outright, a big bulk of those aircraft, I believe 49. And the last CRJ900s traded in the marketplace for a pretty significant amount of money, anywhere from $6 million, $7 million, $8 million, some even traded higher than that, some of those aircraft were just parted out. So we do think that we are creating a fairly significant amount of value in the aircraft over time as we continue to pay down the debt associated with those aircraft.

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Conor T. Cunningham, Cowen and Company, LLC, Research Division - Associate [20]

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Okay. And then I think you mentioned just the potential for deseeding that, the 900s for American? Just curious on how that conversation started. And then what a potential time line might be for a decision to be made there? Is it just -- is it a potential like 3-year thing? Or is it more near-term than that?

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [21]

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No. American has had a tremendous advantage in that they have the ability to fly 65-seat aircraft and not count against their larger aircraft count for scope purposes. It's just at this point, it's a discussion. We think that it's potentially something that makes sense for both parties, and we'll just see how that goes as we move forward. And something certainly that we're cognizant of, and I know American is. But as of now, there's no, by any way, any stretch, any firm decisions, one way or the other.

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Operator [22]

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And our next line is -- came from the line of Savi.

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Matthew Burke Roberts, Raymond James & Associates, Inc., Research Division - Senior Research Associate [23]

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It's Matt again. Sorry, I figured I'd sneak 1 more in. Looking out again into 2021, do you have any color on how the block operations or flight operations for block hour would perform moving into '21? It seems like the fleet count would be kind of steady, but just on how you think of that right now?

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Michael J. Lotz, Mesa Air Group, Inc. - President & CFO [24]

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Yes, this is Mike. So -- let me just take a quick look at it. Yes. So like I said in the -- in my outline, it's going to -- in 2020, we're looking at it going down to the 420 range, so it's going to be 448 -- or mid-440s in 2020. It will go down another 5% in 2021.

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Operator [25]

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At this time, speakers, we don't have any questions on queue.

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [26]

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Okay. All right. Well, again, folks, we certainly appreciate your interest in Mesa. We're very pleased about the United deal, which finally has happened. We continue to be optimistic in terms of our operating performance at American, which has been a tremendous, tremendous focus at the company. We do look forward to launching cargo operations in the second half of 2020, and we continue to look at various financial transactions that will help us lower our interest expense, extend our maturities, help cash flow and just overall benefit the company. I'd like to take 1 second, as always, to thank all of our people. We have just a great group of employees who have just done a fabulous job. It's really, I think the only reason why Mesa is where it is today is that we're all rowing in the same boat, in the same direction. And I just want to thank, not only all our line employees, but as well as our pilot union leadership, our flight attendant union leadership. They have been just very good to work with and have made all this possible.

So again, thank you for your support and your interest. If you have any additional questions, please feel free to call us. We're available anytime. Thank you.

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Operator [27]

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There is still 1 participant who just dialed in. It's Scott -- it came from the line of Scott Buck.

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [28]

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Okay.

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Operator [29]

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Oh, I'm sorry. He get disconnected. Maybe he canceled his question.

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Jonathan G. Ornstein, Mesa Air Group, Inc. - Chairman & CEO [30]

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Okay, no problem. All right. Thank you, operator.

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Operator [31]

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You're welcome. Is there anything else, or if you want me to, or -- that concludes today's conference. Thank you all for participating. You may now disconnect.