Summary of Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2019

Basis of Presentation

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and include the accounts of Harbor Diversified, Inc. and subsidiaries (collectively, Harbor or the Company). The Company’s subsidiaries consist of its wholly owned subsidiaries, Harbor Therapeutics, Inc. (which is a non-operating entity with no material assets), Lotus Aviation Leasing, LLC, Air Wisconsin Funding LLC, and AWAC Aviation, Inc., (AWAC together with AWAC’s wholly owned subsidiary, Air Wisconsin Airlines LLC (Air Wisconsin)).

Description of Operations

Description of Operations

The Company is comprised of principal lines of business focused on (1) providing air transportation (airline business), (2) acquiring aircraft rotable equipment for the purpose of leasing to Air Wisconsin and (3) providing flight equipment financing to Air Wisconsin.

The airline business is operated entirely through Air Wisconsin, an independent regional air carrier that is engaged in the business of providing scheduled passenger service under capacity purchase agreements (CPA) with United Airlines, Inc. (United or UA), and American Airlines, Inc. (American or AA). See Note 3 to the financial statements for further information regarding the service agreements with these partner airlines. The CPA with AA ended in February 2018.

As of December 31, 2019, Air Wisconsin operated as a United Express carrier primarily in Chicago (O’Hare) and Washington, D. C. (Dulles).

Segment Reporting

Segment Reporting

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing operating performance. In consideration of ASC 280, “Segment Reporting,” we are not organized around specific services or geographic regions. We currently operate in one service line providing scheduled flying services in accordance with our CPA with United Airlines. Additionally, our chief operating decision maker uses consolidated financial information to evaluate our performance, which is the same basis upon which the results and performance of the Company are communicated to the Board of Directors. The chief operating decision maker bases all significant decisions regarding the allocation of our resources on a consolidated basis. Based on the information described above and in accordance with the applicable literature, management has concluded that we are organized and operate as one operating and reportable segment.

As further discussed below, all of our operating revenue in 2019 and 2018 was derived from operations associated with our United or American CPAs. It is currently impractical to provide certain information on our revenue from our customers for our services and geographic information on our revenues and long-lived assets.

Contract and Other Revenues

Contract and Other Revenues

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers, (Topic 606)” (“Topic 606”). Under Topic 606, revenue is recognized when the Company satisfies its obligation by transferring control of the good or service to the customer. The Company adopted this standard as of January 1, 2018, utilizing the cumulative effect (modified retrospective) method of adoption and applied the standard only to open contracts. The cumulative effect of adopting Topic 606 resulted in an adjustment to opening retained earnings on January 1, 2018, in the amount of $5,420. Under the new standard the Company concluded that the individual flights are distinct services and the flight services promised in the CPAs represent a series of services that should be accounted for as a single performance obligation recognized over time.

The major airline partners make provisional cash payments to the Company during each month of service based on monthly flight schedules and the provisional cash payments are reconciled based on actual completed flights after each month’s flight activity is completed. As a lessor, for our aircraft operated under our CPA, we have historically accounted for the non-lease component under ASC 606 and have historically accounted for the lease component under ASC 840. As of January 1, 2019, under the available practical expedient under ASC 842, we have elected to account for the lease and non-lease components as a single component for all classes of underlying assets. As the predominant component of the combined components are the flight services, the leases are being accounted for entirely under Topic 606 for the year ended December 31, 2019 (see table below).

Under the nonrefundable up-front fee considerations of Topic 606, payments from United for the up-front fees will be deferred and amortized over the contract term. Under the guidance in ASC 340-40, the related up-front costs to fulfill the contract that were incurred prior to the start of flying for United will also be capitalized and amortized over the contract term. As the amount of the upfront reimbursements received and deferred over the contract term differs from the fulfillment costs that were capitalized, a charge was required to the opening retained earnings in 2018 in the amount of $5,420. This adjustment also resulted in the establishment of a deferred tax asset in the amount of $1,788, which has been classified as a “Contract Liability” deferred tax asset in Note 5. The 2018 income statement has been adjusted to reflect the adoption of Topic 606. The statement of operations in 2018 was negatively impacted by expenses incurred to prepare additional aircraft for service in the amount of $9,439, that were incurred after the performance obligation under the contract had already been partially satisfied in 2017. In addition, amortization of the fulfillment costs capitalized in 2017 resulted in additional amortization expense of $400 for the year ended December 31, 2018. These expenses were partially offset by amortization of deferred upfront costs resulting in revenue of $3,480, and total adjustments decreasing operating income by $6,359. The Company then analyzed the need for a valuation allowance against its deferred tax assets at December 31, 2018, and determined that a valuation allowance in the amount of $457 was necessary (see Note 5 for further details).

The Company recognizes revenue under its CPAs with United and American over time as the service is provided. For the year ended December 31, 2019, revenue from the CPA with United represented 100% of contract revenues. For the year ended December 31, 2018, contract revenues from the Company’s CPAs with United and American were 97.2% and 2.8%, respectively. United pays the Company a fixed rate for each departure and block hour (measured from takeoff to landing, including taxi time), and a fixed amount per aircraft each month, with additional incentives primarily based on flight completion, on-time performance, and customer satisfaction. Under the CPA with United, the Company’s performance obligation is met and revenue is recognized over time and is reflected in contract revenues. Contract revenues by type for the year ended December 31, 2019 and 2018 (in thousands) follows:


For the year ended December 31,	2019		2018
Capacity purchase agreements revenue: flight operations	$	263,495	$	123,375
Capacity purchase agreements revenue: aircraft lease		—		117,177

Contract Revenues	$	263,495	$	240,552

A portion of the Company’s compensation under the CPA is designed to reimburse the Company for certain aircraft ownership costs. For the year ended December 31, 2018, the consideration received for the use of the aircraft under the Company’s CPA is reflected as lease revenue, inasmuch as the agreements identify the “right of use” of a specific number of aircraft over a stated period of time. Under the application of ASC 840 for the year ended December 31, 2018, the Company is required to apply the allocation objective of the new revenue recognition standard (Topic 606) to the lease and non-lease components of the CPA. To meet this allocation objective, the Company calculated a standalone selling price for each distinct cost using a cost-plus margin approach. This resulted in an allocation of 51% of the fixed and variable revenues to the lease component of the CPA when taking into account the executory costs (maintenance, taxes, and insurance), considered to be a part of the lease component under ASC 840. For the year ended December 31, 2018, the lease revenue associated with the Company’s CPA is accounted for as an operating lease and is reflected in contract revenues on the Company’s statements of operations. The Company has not separately stated aircraft rental income in the statements of operations since the use of the aircraft is not a separate activity of the total service provided.

The property associated with the aircraft lease had a cost of $45,896, accumulated depreciation of $5,851, and a net carrying value of $40,045 at December 31, 2018.

The contingent variable revenue associated with the aircraft lease for the year ended December 31, 2018 was $57,252.

The Company’s CPA with United includes weekly provisional cash payments based on a projected level of flying each month. The Company and United subsequently reconcile these payments to the actual completed flight activity on a monthly basis.

Under the CPA with United, the Company is eligible to receive incentive compensation upon the achievement of certain performance criteria. The incentives are defined in the CPA and are measured and determined on a monthly basis. At the end of each month during the term of the CPA, the Company calculates the incentives achieved during that period and recognizes revenue attributable to the CPA accordingly, subject to the variable constraint guidance under Topic 606.

Other revenues are immaterial and primarily consist of the sales of parts to other airlines. The transaction price for the sale of these parts generally occurs at fair market value.

Cash and Cash Equivalents

Cash and Cash Equivalents

Investments and deposits with a maturity of three months or less when acquired and money market funds are considered cash and cash equivalents.

Restricted Cash

Restricted Cash

Restricted cash represents amounts escrowed in an interest-bearing account relating to the Company’s letters of credit.

Spare Parts and Supplies

Spare Parts and Supplies

Expendable parts are stated at average cost less an obsolescence allowance. The Company provides for an allowance for obsolescence after considering the useful life of the aircraft fleet, the estimated cost of expendable parts expected to be on hand at the end of the useful life and the estimated salvage value of the parts. This allowance is based on management estimates and are subject to change. Expendable parts are charged to expense when used. Expendable parts that are repairable are returned to inventory at the average cost of comparable parts, less a reserve for scrap. Supplies are stated at average cost.

Property and Equipment and Depreciation

Property and Equipment and Depreciation

Property and equipment are stated at cost and depreciated over their useful lives to their estimated residual values using the straight-line method as follows:


Assets	Depreciable Life	Current Residual Value
Aircraft	7 years	$	50,000
Rotable parts	7 years		10	%
Spare engines	7 years	$	25,000
Ground equipment	up to 10 years		0	%
Office equipment	up to 10 years		0	%
Leasehold improvements	Shorter of asset or lease life		0	%

Capitalized engine maintenance costs are amortized over their estimated useful life measured in remaining engine cycles to the next scheduled shop event.

Depreciation expense in 2019 and 2018 was $23,578 and $20,363, respectively, and is included in depreciation, amortization, and obsolescence in the accompanying statements of operations.

Impairment of Long-Lived Assets

Impairment of Long-Lived Assets

The Company evaluates long-lived assets for potential impairment and records impairment losses on long-lived assets when events and circumstances indicate the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts. Impairment losses are measured by comparing the fair value of the assets to their carrying amounts. In determining the need to record impairment charges, the Company is required to make certain estimates regarding such things as the current fair market value of the assets and future net cash flows to be generated by the assets. If there are subsequent changes to these estimates, or if actual results differ from these estimates, such changes could impact the financial statements in the future.

Certain factors occurring in 2017 and 2018 resulted in an impairment triggering event that required the Company to evaluate the carrying value of its long-lived property and equipment assets. Such factors included, but were not limited to, the early termination of aircraft residual value guarantees; significantly increased costs to recruit and retain pilots; the termination of the CPA with American Airlines; transition costs associated with the flying agreement with UA; and significantly reduced revenue from UA to cover the Company’s aircraft ownership costs. After reviewing for impairment, the Company recorded an impairment charge during the year ended December 31, 2017. The Company has determined that no further impairment charges on property and equipment were needed for the years ended December 31, 2019 and 2018.

Intangible Assets

Intangible Assets

Indefinite-lived intangible assets are not subject to amortization but are subject to an annual assessment for impairment by applying a fair value-based test. The trade names and the air carrier certificate have indefinite lives, therefore, there is no amortization.

Maintenance

Maintenance

The Company operates its aircraft under a continuous inspection and maintenance program. The normal cost of recurring maintenance is expensed when incurred except for planned major maintenance activities for engines where the deferral method of accounting is applied.

Income Taxes

Income Taxes

The Company utilizes the asset and liability method for accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are determined based upon the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities, as measured by the current applicable tax rates. Deferred tax expense represents the result of changes in deferred tax assets and liabilities.

As required by the uncertain tax position guidance, the Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority would more-likely-than-not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority. The Company has applied the uncertain tax position guidance to all tax positions for which the statute of limitations remains open.

The Company is subject to income taxes in the United States (U.S.) federal jurisdiction and various state jurisdictions. Tax regulations within each jurisdiction are subject to the interpretation of the related tax laws and regulations and require significant judgment to apply. The Company is no longer subject to U.S. federal income tax examinations for the years prior to 2015. With few exceptions, the Company is no longer subject to state, and local income tax examinations for the years prior to 2014. As of December 31, 2019, the Company had no outstanding tax examinations.

The Company recognizes interest and penalties related to unrecognized tax benefits in income tax expense for all periods presented. The Company had accrued $121 and $252 for the payment of interest and penalties at December 31, 2019 and 2018, respectively.

Comprehensive Income

Comprehensive Income

The Company does not have any components of comprehensive income and, as of December 31, 2019 and 2018, comprehensive income is equal to net income reported in the statements of operations.

Concentration of Credit Risk

Concentration of Credit Risk

The Company at times has had cash in excess of the Federal Deposit Insurance Corporation (FDIC) insurance limit. As of December 31, 2019, there were no bank deposits that exceeded the FDIC insurance limits.

Substantially all the Company’s revenues in 2019 and 2018 were derived from United (see Note 3).

Estimates

Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Fair Value of Financial Instruments

Fair Value of Financial Instruments

The Company’s financial instruments include cash and cash equivalents, restricted cash, accounts receivable, long-term investments, accounts payable, and long-term debt. The Company believes the carrying amounts of these financial instruments are a reasonable estimate of their fair value because of the short-term nature of such instruments, or in the case of long-term debt, because of interest rates available to the Company for similar obligations. Long-term investments are held-to-maturity debt securities and are reported at amortized cost.

Fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date (that is, an exit price). Accounting Standards Codification (ASC) 820 establishes a three-tier fair value hierarchy, which prioritizes inputs used in fair value. The tiers are as follows:

Level 1 - Quoted market prices in active markets for identical assets or liabilities.

Level 2 - Inputs other than Level 1 inputs that are either directly or indirectly observable.

Level 3 - Unobservable inputs developed using the Company’s estimates and assumptions, which reflect those that market participants would use.

The determination of where an asset or liability falls in the hierarchy requires significant judgment. The Company evaluates its hierarchy disclosures annually and based on various factors, it is possible that an asset or liability may be classified differently from year to year. However, the Company expects that changes in classifications between different levels will be rare. The Company classifies money market funds and deposits as Level 1 and long-term investments as Level 2. There have been no transfers between Level 1 and Level 2 investments during 2019.

Recently Adopted Standards

Recently Adopted Standards: ASU 2014-09

In May 2014, the FASB issued Accounting Standards Update No. 2014-09, “Revenue from Contracts with Customers, (Topic 606)”. The adoption of Topic 606 resulted in changes to the Company’s accompanying financial statements for the year ended December 31, 2018. The change resulted in a charge to the Company’s opening retained (deficit) earnings in the amount of $5,420 as of January 1, 2018. This change also resulted in a contract liability and a capitalized contract cost on the balance sheet. The total contract liabilities and upfront costs upon adoption of Topic 606 were $9,725 and $2,068, respectively. The amounts of contract liabilities amortized for the years ended December 31, 2019 and 2018, were $3,725 and $3,480, respectively. The amounts of contract costs amortized for the years ended December 31, 2019 and December 31, 2018, were $400 for each year.

The Company recast certain prior period amounts to conform to the adoption of Topic 606, as shown in the tables below (in thousands):


Balance Sheet	Previously Reported December 31, 2018		Adjustment		As Adjusted December 31, 2018
Assets
Contract costs	$	—	$	400	$	400
Long-term contract costs		—		1,268		1,268

Total Assets	$	—	$	1,668	$	1,668

Liabilities
Contract liability	$	—	$	3,725	$	3,725
Long-term contract liability		—		11,510		11,510

Total Liabilities	$	—	$	15,235	$	15,235

The $1,668 and the $15,235 adjustment to contract assets and contract liabilities, respectively, reflects the amount of capitalized up-front contract costs and the amount of contract liabilities for up-front reimbursements as of December 31, 2018. These amounts are expected to be amortized over the applicable remaining contract term on a straight-line basis. For the year ended December 31, 2019 and 2018, the Company recorded $400 in both years associated with the amortization of the contract assets. For the year ended December 31, 2019 and 2018, the Company recognized $3,725 and $3,480, respectively, of revenue associated with the amortization of the up-front contract reimbursements.

In December 2019 and 2018, the Company received payments of $5,539 and $4,999 from UA for services to be rendered in January 2020 and January 2019, respectively. The Company recast the December 31, 2018, amount of $4,999 from accounts payable to contract liabilities on the balance sheet. These customer deposits have been recorded as contract liabilities in the balance sheets as of December 31, 2019 and 2018, and recorded as revenue in January 2020 and 2019, respectively.

The statement of operations was recast as follows for the year ended December 31, 2018 (in thousands):


	For the Year Ended December 31, 2018
	Previously Reported			Adjustments			As Adjusted
Operating Revenues
Contract revenues	$	243,272		$	(2,720	)	$	240,552
Operating Expenses
Aircraft maintenance repair		51,879			3,239			55,118
Amortization expense		21,745			400			22,145

Loss from Operations		(18,139	)		(6,359	)		(24,498	)
Income Tax (Benefit)		(4,297	)		(827	)		(5,124	)

Net Income	$	186,845		$	(5,532	)	$	181,313

Explanations for each of the adjustments above are as follows:

•

Contract revenues – revenue of $6,200 was deferred as a contract liability and is partially offset by the amortization of the contract liability in the amount of $3,480.

•

Aircraft maintenance and repair – cost incurred in preparing the aircraft for service which were previously treated as a reimbursed expense.

•

Amortization expense – amortization of capitalized contract costs.

•

Income tax benefit – changes due to Topic 606 resulted in an increased loss from operations in the amount of $6,359. This resulted in an income tax benefit and additional deferred tax asset in the amount of $1,284, offset by the creation of a federal and state valuation allowance of $457 on deferred tax assets.

Recently Adopted Standards: ASU 2016-02

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“Topic 842”). ASU 2016-02 is intended to improve financial reporting of leasing transactions by requiring organizations that lease assets to recognize assets and liabilities for the rights and obligations created by leases on the balance sheet. The accounting update also requires additional disclosures surrounding the amount, timing, and uncertainty of cash flows arising from leases. The Company adopted Topic 842 effective January 1, 2019 and elected the package of transition practical expedients for expired or existing contracts, which does not require reassessment of: (1) whether any of the Company’s contracts are or contain leases, (2) lease classification, and (3) initial direct costs. In July 2018, the FASB issued ASU No. 2018-11, “Targeted Improvements – Leases (Topic 842).” This update provides an optional approach that allows entities to elect to apply the standard using the modified retrospective approach at its effective date, versus recasting the prior years as presented. If this adoption method is elected, an entity would recognize a cumulative-effect adjustment to the opening balance of retained earnings in the year of adoption. The Company elected this adoption method, however, an adjustment was not necessary to opening retained earnings.

Additionally, the Company’s adoption of Topic 842 did not have a significant impact on the recognition, measurement or presentation of lease revenue and lease expenses within the financial statements of operations and statement of cash flows. The Company’s prepaid aircraft rents and accrued aircraft rents that were separately stated in the Company’s December 31, 2018 balance sheet have been classified as a component of the Company’s right-of-use assets effective January 1, 2019. The financial statements for 2019 are presented under the new standard, while the comparative year presented is not adjusted and continues to be reported in accordance with the Company’s historical accounting policy.

As a result of the adoption of the new lease accounting guidance, the Company recognized the following ROU assets and lease liabilities as of January 1, 2019:


Right-of-use assets – operating leases	$	70,892
Lease liabilities – operating leases	$	40,921