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Summary of Significant Accounting Policies (Policies)

9 Months Ended

Sep. 30, 2022

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP) and include the accounts of Harbor Diversified, Inc. (Harbor) and its subsidiaries (collectively, the Company).

Harbor

is a non-operating holding company

that is the parent of a consolidated group of subsidiaries, including AWAC Aviation, Inc. (AWAC), the sole member of Air Wisconsin Airlines LLC (Air Wisconsin), which is a regional air carrier. Harbor is also the direct parent of three other subsidiaries: (1) Lotus Aviation Leasing, LLC (Lotus), which leases flight equipment to Air Wisconsin, (2) Air Wisconsin Funding LLC (AWF), which provides flight equipment financing to Air Wisconsin, and (3) Harbor Therapeutics, Inc. (Therapeutics), which

is a non-operating entity with

no material assets.

The consolidated financial statements have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the following disclosures are adequate to make the information presented not misleading. The consolidated financial statements reflect all adjustments that, in the opinion of management, are necessary to present fairly in all material respects the financial condition and results of operations for the interim periods presented. All adjustments are of a normal recurring nature, unless otherwise disclosed. All of the dollar and share amounts set forth in these condensed notes to consolidated financial statements are presented in thousands except per share and par value amounts.

These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in Harbor’s Annual Report on Form

10-K

for the year ended December 31, 2021, which was filed with the SEC on March 30, 2022 (2021 Annual Report). Due in part to the significant impacts to the Company’s business and industry from the industry-wide pilot shortage and the global coronavirus

(COVID-19)

pandemic, in addition to other factors discussed below, the results of operations for the three and nine months ended September 30, 2022 are not necessarily indicative of the results that may be expected for any other reporting period.

Description of Operations

The Company has principal lines of business focused on (1) providing regional air services through Air Wisconsin (airline business), (2) acquiring flight equipment for the purpose of leasing the equipment to Air Wisconsin, and (3) providing flight equipment financing to Air Wisconsin. Additionally, Air Wisconsin is exploring aircraft leasing opportunities and entered into its first short-term aircraft lease in September 2022.

The airline business is operated entirely through Air Wisconsin, which is an independent regional air carrier that is engaged in the business of providing scheduled passenger service under a capacity purchase agreement (United capacity purchase agreement) with United Airlines, Inc. (United) that was entered into in February 2017 and amended in October 2020, April 2021, April 2022, June 2022, and September 2022. United is currently Air Wisconsin’s sole airline partner; however, Air Wisconsin entered into a separate capacity purchase agreement in August 2022 (American capacity purchase agreement) with American Airlines, Inc. (American) pursuant to which Air Wisconsin has agreed to provide up to 60

CRJ-200

regional jet aircraft for regional airline services for American. Air Wisconsin expects to commence flying operations for American in March 2023. American will become Air Wisconsin’s sole airline partner once all aircraft are removed from United’s flying operations, which is expected to occur throughout 2023. For additional information, refer to Note 3,

Capacity Purchase Agreements with United and American

and Part II, Item 5, “

American Capacity Purchase Agreement

” within this Quarterly Report.

Air Wisconsin currently operates as a United Express carrier with a presence at both Chicago O’Hare and Washington-Dulles, two of United’s key domestic hubs.

Contract Revenues

The Company recognizes revenue under the United capacity purchase agreement over time as services are provided. United pays Air Wisconsin a fixed rate for each departure and block hour (measured from takeoff to landing, including taxi time), and a fixed amount per aircraft per day, with incentive payments available, and penalties payable, based on the achievement, or failure to achieve, certain performance criteria. Under the agreement, Air Wisconsin’s performance obligation is met and revenue is recognized over time, which is then reflected in contract revenues. The agreement also provides for the reimbursement to Air Wisconsin of certain direct operating expenses such as hull and liability insurance, property taxes and Canadian navigational fees.

United makes provisional cash payments to Air Wisconsin during each month of service based on projected flight schedules. These provisional cash payments are subsequently reconciled with United based on actual completed flight activity. As of the date of this filing, these payments are reconciled through July 2022. Subject to final reconciliation of the provisional cash payments for the periods after July 31, 2022, as of September 30, 2022, United owed Air Wisconsin approximately $22,302, which is recorded in accounts receivable, net, on the consolidated balance sheets. United is disputing that it owes $18,693 of this amount. For additional information regarding the dispute with United, refer to Note 8,

Commitments and Contingencies.

Under the United capacity purchase agreement, Air Wisconsin is eligible to receive incentive payments, or may be required to pay penalties, upon the achievement of, or failure to achieve, certain performance criteria primarily based on flight completion,

on-time

performance, and customer satisfaction ratings. The incentives are defined in the agreement and performance is measured on a monthly basis. At the end of each month during the term of the agreement, Air Wisconsin calculates the incentives achieved, or penalties payable, during that period and recognizes revenue accordingly, subject to the variable constraint guidance under Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 606,

Revenue from Contracts with Customers

(Topic 606). Although the final reconciliations have not been completed for all periods, after considering operational performance related to expected incentive and penalty payments, Air Wisconsin has received (incurred), or is likely to receive (incur), net payments of $2,137 and $(339) for the three months ended September 30, 2022 and September 30, 2021, respectively, and $5,443 and $2,820 for the nine months ended September 30, 2022 and September 30, 2021, respectively. These amounts are recorded in accounts receivable, net, on the consolidated balance sheets.

Under the United capacity purchase agreement, Air Wisconsin is paid a fixed amount per aircraft per day for each month during the term of the agreement. In accordance with GAAP, the Company recognizes revenue related to the fixed payments on a proportional basis taking into account the number of flights actually completed in that period relative to the number of flights expected to be completed in subsequent periods during the remaining term of the agreement. Air Wisconsin deferred fixed revenues between April 2020 and June 2021 due to the significant decrease in its completed flights as a result of the

COVID-19

pandemic. Beginning in July 2021, due to an increase in completed flights and based on projected future completed flight activity, Air Wisconsin began reversing this deferral of fixed revenues, and it anticipates continuing to do so through the wind-down period under the United capacity purchase agreement (wind-down period). Accordingly, during the three and nine months ended September 30, 2022, Air Wisconsin recognized $5,180 and $22,548, respectively, of fixed revenues that were previously deferred, compared to a deferral of $5,298 and $10,054 of fixed revenues in the three and nine months ended September 30, 2021, respectively. Air Wisconsin’s deferred revenues related to the fixed portion of revenue under the United capacity purchase agreement will adjust over the remaining contract term, including the wind-down period, based on the number of flights completed in each reporting period relative to the number of flights anticipated to be completed through the end of the wind-down period. As of September 30, 2022, deferred fixed revenues in the amount of $22,290 were recorded as part of deferred revenues on the consolidated balance sheets. For additional information regarding the wind-down schedule with United, refer to Note 2,

Liquidity

Consistent with the discussion above, for the three and nine months ended September 30, 2022, as compared to the three and nine months ended September 30, 2021, Air Wisconsin also recognized increased

non-refundable

upfront fee revenues and increased fulfillment costs, both of which are amortized over the remaining term of the United capacity purchase agreement in proportion to the number of flights actually completed in that period relative to the number of flights expected to be completed in subsequent periods. During the three and nine months ended September 30, 2022, Air Wisconsin recorded $932 and $3,314 of revenue from upfront fees and $100 and $355 of fulfillment costs, respectively, compared to $1,082 and $2,428 in revenue from upfront fees and $116 and $260 of fulfillment costs for the three and nine months ended September 30, 2021, respectively. As of September 30, 2022, deferred upfront fee revenue in the amount of $2,406 is recorded as part of contract liabilities on the consolidated balance sheets.

As part of the October 2020 amendment to the United capacity purchase agreement (CPA Amendment), United made a cash settlement payment of $670 and issued a note receivable to Air Wisconsin in the amount of $11,048, of which $4,410 was deferred as of December 31, 2020, with the remaining portion to be recognized in proportion to the number of flights expected to be completed in subsequent periods through the end of the wind-down period. In October 2021, in accordance with the CPA Amendment, Air Wisconsin received $294 from United for the opening of a crew base, of which $73 was deferred as of December 31, 2021. For the three and nine months ended September 30, 2022, Air Wisconsin recorded $453 and $1,611 of revenue related to these items,

respectively, compared to $512 and $1,150 of revenue related to these items for the three and nine months ended September 30, 2021, respectively. As of September 30, 2022, deferred CPA Amendment revenue in the amount of $1,170, is recorded as part of contract liabilities on the consolidated balance sheets.

The timing of the recognition of deferred fixed revenue,

non-refundable

upfront fee revenue, fulfillment costs, and deferred CPA Amendment revenue in future periods is subject to considerable uncertainty due to a number of factors, including the actual number of completed flights in any particular period relative to the estimated number of flights anticipated to be flown through the end of the wind-down period.

The amount of revenues recognized for the three and nine months ended September 30, 2022 that were previously recorded as contract liabilities were $1,385 and $4,925, respectively.

The CPA Amendment provided, among other things, for the payment or accrual of certain amounts by United to Air Wisconsin based on certain scheduling benchmarks. In conjunction with the significant reduction in departures and block hours resulting from the

COVID-19

pandemic in 2020, and consistent with the terms of the CPA Amendment, management determined that, from an accounting perspective, a new performance obligation was created by United, requiring Air Wisconsin to stand ready to deliver flight services. Air Wisconsin determined, using the expected cost plus a margin method, that the United “stand ready” rate represents the relative stand-alone selling price of the performance obligation. The stand ready performance obligation will be recognized over time on a straight-line basis based on the number of unscheduled block hours below a minimum threshold at the stand ready rate as determined in a manner consistent with the CPA Amendment. For the three and nine months ended September 30, 2022, Air Wisconsin recorded $5,138 and $12,746, respectively, in revenue related to this performance obligation compared to $728 and $13,699 for the three and nine months ended September 30, 2021, respectively. Under the CPA Amendment, United is required to accrue this amount and, upon request by Air Wisconsin, deliver a note evidencing this amount each quarter, which notes are due and payable in February 2023. Therefore, this amount is recorded in notes receivable on the consolidated balance sheets. The notes receivable contain a significant financing component and any interest income is separately reported in the consolidated statements of operations. As of September 30, 2022, the principal amount of these notes totaled $60,315, including the $11,048 note receivable described above, bore interest at the rate of 4.5%, and had a maturity date of February 28, 2023. As of September 30, 2022, interest receivable on these notes, including the disputed notes, totaled $3,954 and is recorded in accounts receivable, net on the consolidated balance sheets. United has disputed that it owes these amounts in respect of certain quarters and has refused to deliver notes for those quarters. The amount in dispute in respect of those notes as of the date of this filing totals $14,175, including interest receivable of $174. On November 4, 2022, United prepaid to Air Wisconsin $50,126 to satisfy

all of

the outstanding, undisputed notes receivable, including all accrued interest, pursuant to the CPA Amendment in respect of the period of the second quarter 2020 through the third quarter 2021 and the $11,048 note receivable described above. For additional information regarding the dispute with United, refer to Note 8,

Commitments and Contingencies.

Other Revenues

Other revenues primarily consist of the sales of parts to other airlines and aircraft lease. These other revenues are immaterial in all periods presented. The transaction price for these other revenues generally is fair market value.

Restricted Cash

As of September 30, 2022 and December 31, 2021, the Company had a restricted cash balance of $418 and $1,449, respectively. A portion of the balance secures a credit facility for the issuance of letters of credit guaranteeing the performance of Air Wisconsin’s obligations under certain lease agreements, airport agreements and insurance policies. The remaining portion is cash held for the repurchase of shares under Harbor’s stock repurchase program. For additional information, refer to Note 8,

Commitments and Contingencies

, and Note 13,

Stock Repurchase Program.

Marketable Securities

The Company’s equity security investments, consisting of exchange-traded funds and mutual funds, are recorded at fair value based on quoted market prices (Level 1) in marketable securities on the consolidated balance sheets, in accordance with the guidance in ASC Topic 321,

Investments-Equity Securities

, with the change in fair value during the period included in the consolidated statements of operations. As of September 30, 2022 and December 31, 2021, the fair value of the Company’s marketable securities was $130,517 and $138,370, respectively.

The calculation of net unrealized gains and losses that relate to marketable securities held as of September 30, 2022 is as follows:


	Three Months Ended September 30, 2022			Nine Months Ended September 30, 2022
Net losses recognized during the period on equity securities	$	(3,749	)	$	(9,774	)
Less: Net gains and losses recognized during the period on equity securities sold during the period		—			—

Unrealized losses recognized during the period on equity securities held as of September 30, 2022	$	(3,749	)	$	(9,774	)

The calculation of net unrealized gains and losses that relate to marketable securities held as of September 30, 2021 is as follows:


	Three Months Ended September 30, 2021			Nine Months Ended September 30, 2021
Net gains and losses recognized during the period on equity securities	$	(92	)	$	(106	)
Less: Net losses recognized during the period on equity securities sold during the period		42			1

Unrealized gains recognized during the period on equity securities held as of September 30, 2021	$	(134	)	$	(107	)

Property and Equipment

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
Rotable parts	7 years		10	%
Spare engines	7 years	$	25
Ground equipment	up to 10 years		0	%
Office equipment	up to 10 years		0	%
Leasehold improvements	Shorter of asset or lease life		0	%

Air Wisconsin’s capitalized engine maintenance costs are amortized over their estimated useful life measured in remaining engine cycles to the next scheduled shop visit. Lotus’ engine maintenance costs are expensed.

For the three and nine months ended September 30, 2022, the Company recorded depreciation expense of $6,224 and $18,656, respectively, compared to $6,274 and $18,769 for the three and nine months ended September 30, 2021, respectively.

Impairment of Long-Lived and Intangible Assets

The Company evaluates long-lived and intangible assets for potential impairment and records impairment losses 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 and assumptions 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 assumptions, or if actual results differ from these estimates or assumptions, such changes could impact the financial statements in the future. The Company conducted a qualitative impairment assessment of its long-lived and intangible assets and determined that no quantitative impairment tests were required to be performed as of September 30, 2022.

Income Taxes

The Company utilizes the asset and liability method for accounting for income taxes. Under this 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 federal, state and local income taxes in the United States and various states. 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 2018. With a few exceptions, the Company is no longer subject to state or local income tax examinations for years prior to 2017. As of September 30, 2022, the Company had no outstanding tax examinations.

Concentration of Customer Risk

United is currently Air Wisconsin’s sole airline partner. Substantially all the Company’s revenues in the three and nine months ended September 30, 2022 and September 30, 2021 were derived from the United capacity purchase agreement.

Air Wisconsin entered into the American capacity purchase agreement in August 2022 and expects to commence flying operations for American in March 2023. American will become Air Wisconsin’s sole airline partner once all aircraft are removed from United’s flying operations.

For additional information, refer to Note 3,

Capacity Purchase Agreements with United and American

and Part II, Item 5, “

American Capacity Purchase Agreement

” within this Quarterly Report.

Estimates and Assumptions

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the 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 materially from those estimates.

Fair Value of Financial Instruments

The Company’s financial instruments include cash and cash equivalents, restricted cash, marketable securities, accounts receivable, long-term investments, accounts payable, and long-term debt. The Company believes the carrying amounts of these financial instruments, with the exception of marketable securities, 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. Marketable securities are reported at fair value based on quoted market prices. 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).

Fair Value Measurement

(Topic 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 these determinations each reporting period, and it is possible that an asset or liability may be classified differently from year to year.

The tables below set forth the Company’s classification of marketable securities and long-term investments as of the periods presented:


	September 30, 2022
	Total		Level 1		Level 2		Level 3
Marketable securities – exchange-traded funds	$	106,087	$	106,087	$	—	$	—
Marketable securities – mutual funds		24,430		24,430		—		—
Long-term investments – bonds (see Note 6)		4,275		—		4,275		—

Total	$	134,792	$	130,517	$	4,275	$	—


	September 30, 2021
	Total		Level 1		Level 2		Level 3
Marketable securities – exchange-traded funds	$	108,097	$	108,097	$	—	$	—
Marketable securities – mutual funds		18,446		18,446		—		—
Long-term investments – bonds (see Note 6)		4,275		—		4,275		—

Total	$	130,818	$	126,543	$	4,275	$	—

Reclassifications

Reclassification

Certain operating expenses previously recorded in purchased services and other in the consolidated statements of operations in the amounts of $3,185 and $8,265 for the three and nine months ended September 30, 2021, respectively, have been reclassified to aircraft maintenance, materials and repairs to conform to the presentation for the three and nine months ended September 30, 2022, with no effect on net income. The reclassification relates to certain third party maintenance activities.

Certain current liabilities previously recorded in contract liabilities in the consolidated balance sheets as of December 31, 2021 have been reclassified to deferred revenue in the amount of $35,792 to conform to the presentation as of September 30, 2022. As a result of this change, the consolidated statements of cash flows also required a reclassification from contract liabilities in the amount of $27,961 to deferred revenues in the

Cash Flows from Operating Activities

section of the consolidated statements of cash flows.

Upcoming Accounting Pronouncement

In June 2016, FASB issued ASU

2016-13,

Financial Instruments—Credit Losses

(Topic 326):

Measurement of Credit Losses on Financial Instruments

(ASU

2016-13).

ASU

2016-13

introduces a new accounting model known as Current Expected Credit Losses (CECL). CECL requires earlier recognition of credit losses, while also providing additional transparency about credit risk. The CECL model utilizes a lifetime expected credit loss measurement objective for the recognition of credit losses for receivables at the time the financial asset is originated or acquired. The expected credit losses are adjusted each period for changes in expected lifetime credit losses. This model replaces the multiple existing impairment models in current GAAP, which generally require that a loss be incurred before it is recognized. The new standard will also apply to receivables arising from revenue transactions such as contract assets and accounts receivable. There are other provisions within the standard affecting how impairments of other financial assets may be recorded and presented, as well as expanded disclosures. ASU

2016-13

is effective for calendar years beginning after December 15, 2022, including interim periods within those calendar years, with early adoption permitted. The Company is currently evaluating the impact ASU

2016-13

will have on its consolidated financial statements.