Surf Air Mobility Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis reflects the historical results of operations and financial position of Surf Air Mobility Inc., and its consolidated subsidiaries. Prior to the Internal Reorganization (as defined below) on July 21, 2023, these results were comprised of the operations of Surf Air Global, Limited., the predecessor to Surf Air Mobility Inc. References in this section to the “Company”, “we” or “our” refer to Surf Air Mobility Inc, and its consolidated subsidiaries, including Southern Airways Corporation. Unless otherwise indicated, all dollar amounts are set forth in thousands, except share and per share data.

The following discussion and analysis is intended to help the reader understand the Company’s results of operations and financial condition. This discussion and analysis is provided as a supplement to, and should be read in conjunction with, the information included in Item 1. Financial Statements in this Quarterly Report on Form 10-Q. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to the Company’s plans and strategy for its business, includes forward-looking statements that involve risks and uncertainties. The Company’s actual results may differ materially from management’s expectations as a result of various factors, including but not limited to those discussed in the sections entitled “Risk Factors” and “Special Note Regarding Forward-Looking Statements” included within the Company’s Registration Statement on Form S-1 filed on November 9, 2023 (the “Registration Statement”).

Overview of the Business

Surf Air Mobility Inc. (the “Company”), a Delaware corporation, is building a regional air mobility ecosystem that will aim to sustainably connect the world’s communities. The Company intends to accelerate the adoption of green flying by developing, together with its commercial partners, hybrid-electric and fully-electric powertrain technology to upgrade existing fleets, and by creating a financing and services infrastructure to enable this transition on an industry-wide level.

Surf Air Global Limited (“Surf Air”) is a British Virgin Islands holding company and was formed on August 15, 2016. Surf Air is a technology-enabled regional air travel network, offering daily scheduled flights and on-demand charter flights. Its customers consist of regional business and leisure travelers. Headquartered in Hawthorne, California, Surf Air commenced flight operations in June 2013.

Internal Reorganization

On July 21, 2023, SAGL Merger Sub Inc., a wholly-owned subsidiary of the Company, was merged with and into Surf Air, after which Surf Air became a wholly-owned subsidiary of the Company (the “Internal Reorganization”).

Pursuant to the Internal Reorganization, all ordinary shares of Surf Air outstanding as of immediately prior to the closing, were canceled in exchange for the right to receive shares of the Company’s common stock and all rights to receive ordinary shares of Surf Air (after giving effect to the conversions) were exchanged for shares of the Company’s common stock (or warrants, options or RSUs to acquire the Company’s common stock, as applicable) at a ratio of 22.4 Surf Air ordinary shares to 1 share of the Company’s common stock. Such conversions, as they relate to the ordinary shares of Surf Air, and all rights to receive ordinary shares, have been reflected as of all periods presented herein.

On July 27, 2023, the Company’s common stock was listed for trading on the New York Stock Exchange.

As the Internal Reorganization did not take effect until the quarter ended September 30, 2023, the historical financial statements presented in this Quarterly Report on Form 10-Q reflect the financial position, results of operations and cash flows of Surf Air, the predecessor to the Company, for all periods prior to the date of the Internal Reorganization.

Southern Acquisition

On July 27, 2023 (the “Acquisition Date”), immediately prior to the Company’s listing on the New York Stock Exchange and after the consummation of the Internal Reorganization, the Company effected the acquisition of all equity interests of Southern Airways Corporation (“Southern”), whereby a wholly-owned subsidiary of the Company merged with and into Southern, after which Southern became a wholly-owned subsidiary of the Company (the “Southern Acquisition”). Pursuant to the Southern Acquisition, Southern stockholders received 16,250,000 shares of the Company's Common Stock.

Southern, a Delaware corporation founded on April 5, 2013, and its wholly owned subsidiaries Southern Airways Express, LLC, Southern Airways Pacific, Southern Airways Autos, LLC, and Multi-Aero Inc. are collectively referred to hereafter as “Southern.” Southern is a scheduled service commuter airline serving cities across the United States that is headquartered in Palm Beach, Florida and commenced flight operations in June 2013. It is a certified Part 135 operator which operates a fleet of over 50 aircraft, including the Cessna Caravan, the Cessna Grand Caravan, the King Air Super 200, the Saab 340, the Pilatus PC-12, the Tecnam Traveller, and the Citation Bravo. Southern provides both seasonal and full-year scheduled passenger air transportation service in the Mid-Atlantic and Gulf regions, Rockies and West Coast, Far Pacific, and Hawaii, with select routes subsidized by the United States Department of Transportation (“U.S. DOT”) under the Essential Air Service (“EAS”) program.

The Southern Acquisition resulted in a combined regional airline network servicing U.S. cities across the Mid-Atlantic, Gulf South, Midwest, Rocky Mountains, West Coast, New England and Hawaii.

The results of operations of Southern are included in the Company’s condensed consolidated financial statements from the date of acquisition, July 27, 2023, through September 30, 2023. For historical financial information of Southern, prior to the Acquisition Date, refer to the sections entitled “Unaudited Condensed Consolidated Financial Statements for Southern Airways Corporation” and “Audited Financial Statements for Southern Airways Corporation as of December 31, 2022 and 2021 and for the Years Ended December 31, 2022 and 2021” in the Registration Statement, as well as the Form 8-K/A filed August 29, 2023.

2023 Operating Environment

Since 2020, the Company has been incurring expenses to support the development of the technology of its digital platform with the aim of providing a delightful, premium flying experience and the Company expects these development expenses to continue to be incurred. Additionally, the Company is developing hybrid-electric and fully-electric powertrain technologies with its commercial partners to electrify existing fleets and new aircraft. As a result, the Company expects to incur significant costs in the future to support the development of this technology.

Beginning in early 2020, the effects and potential effects of the global COVID-19 pandemic, including, but not limited to, its impact on general economic conditions, trade and financing markets, changes in customer behavior with regard to air mobility services, and continuity in business operations created significant uncertainty for the Company. The Company has seen some recovery in on-demand flights from 2021 through the third quarter of 2023, however the Company’s business has been and will continue to be affected by many changing economic and other conditions beyond the Company’s control, including global events that affect travel behavior. The spread of COVID-19 also disrupted the manufacturing, delivery and overall supply chain of aircraft manufacturers and suppliers and has led to a global decrease in aircraft sales in markets around the world. The Company has experienced inflationary pressures, which have materially increased the Company’s costs for aircraft fuel, wages and benefits and other goods and services critical to its operations during 2022 and 2023 and believes perceived recessionary risks may impact 2023 results. For example, perceived recessionary risks may cause companies and individuals to reduce travel for either professional or personal reasons, and drive higher prices in the supply chain the Company relies upon. In addition, the Company incurred greater than expected losses and negative cash flows from operating activities during the third quarter of 2023 due to inefficient aircraft utilization, primarily caused by an underutilization of pilots and a shortage of maintenance personnel and critical aircraft components, which, in aggregate, have challenged the Company’s ability to serve its customers as desired and, in turn, cover expenses.

As such, the extent to which global events and market inflationary impacts will affect our financial condition, liquidity and future results of operations is uncertain. Given the uncertainty regarding the length of these factors, the Company cannot reasonably estimate their impact on its future results of operations, cash flows or financial condition. The Company continues to actively monitor its financial condition, liquidity, operations, suppliers, industry and workforce. As the Company does not currently, and does not intend in the foreseeable future to, enter into any transactions to hedge fuel costs, or otherwise fix labor costs, the Company will continue to be fully exposed to fluctuations in prices of material operating costs.

Key Operating Measures

In addition to the data presented in our consolidated financial statements, we use the following key operating measures commonly used throughout the air transport industry to evaluate our business, measure our performance, develop financial forecasts and make strategic decisions. The following table summarizes key operating measures for each period presented below, which are unaudited.

Components of the Company’s Results of Operations

The key components of our results of operations include:

Revenue

The Company’s revenue is comprised of scheduled flight services and on-demand trips.

Scheduled Revenue

Scheduled revenue is derived from EAS, passenger single seat purchases, membership subscriptions principally relating to two main categories of membership subscriptions: All You Can Fly (“AYCF”) and Pay As You Fly (“PAYF”), and other revenue.

EAS revenue is derived from operating scheduled passenger flight service on certain routes, which are subsidized by the U.S. DOT under its EAS program. The EAS program was enacted in 1978 to ensure small communities in the United States can maintain a minimum level of scheduled air services. Contracts under this program are typically two to four years in duration and include commitments to fly a specific number of times annually to each location. Revenue from EAS subsidies is recognized monthly. Revenue from sales of tickets on flights subsidized by the EAS program is recognized in direct passenger revenue and is recognized when the flights are completed.

Direct passenger revenue consists of single seat tickets for scheduled flight service. Tickets are refundable within 24 hours of purchase for flights scheduled to take place more than one week out, or when flights are changed, interrupted or otherwise canceled. Direct passenger sales revenues are recognized when the flights are completed or when tickets expire (generally within one year from the date of purchase).

AYCF membership subscriptions allow members to book unlimited flights over the contract service term (monthly or annually). The membership fee includes the subscription and single seat fees. AYCF membership fees are billed monthly in advance, and revenue is recognized on a month-to-month basis over the service term.

PAYF membership subscriptions allow members to purchase single use vouchers for travel on the Company’s scheduled routes. Vouchers sold in a package generally expire twelve months after the purchase date. Vouchers are nonrefundable, not exchangeable for cash and may not be used for other services. Revenue is recognized for the membership fee and the purchase of vouchers, based on the pattern of voucher usage, or at expiration, whichever comes first.

Other revenue is derived from various ancillary services related to baggage fees, reservation change fees and pet (carry-on) fees. These types of fees are standard within the aviation industry and are earned when the services are performed at the time of travel.

On-Demand Revenue

On-demand service allows customers to book an individual flight on routes specified by the customer. Customers can purchase single flights or prepaid, dollar based, credits. Single flights are paid for at booking. Flight credits are paid upon purchase and applied at booking.

The Company utilizes a combination of its own aircraft and FAA certified independent third-party air carriers in the performance of its charter flights on Surf Air. The Company evaluates whether it is a principal or an agent in contracts involving more than one party by assessing whether it controls the flight services before they are transferred to its customers.

The Company acts as the principal when it controls the services by directing third-party air carriers and operators to provide services to customers on its behalf. The Company controls the services when it is primarily responsible for fulfillment of the flight services obligation to the customer and has pricing discretion. In these arrangements, revenue recognized is the gross amount of the contract consideration paid by customers. When the Company is not primarily responsible for the fulfillment of the flight services, it acts as an agent and therefore recognized revenue is net of amounts paid to third-party air carriers and operators that provide the services. The majority of the On-Demand revenue was recognized on a gross basis. Customers purchase prepaid credits for on-demand services, and the revenue derived from these prepaid credits is recognized when the trip is flown.

Operating Expenses

Cost of Revenue, exclusive of depreciation and amortization

Cost of revenue consists of expenditures directly related to delivering services and related facility costs. Service delivery costs are primarily comprised of fees paid to the independent third-party air carriers operating both scheduled flight services and on-demand services when Surf Air is acting as the principal in the arrangement. Additionally, cost of revenue includes all personnel costs for pilots, member services and ground concierge staff. Aircraft expenses represent maintenance, materials, repairs, fuel, maintenance labor and aircraft leases to support the scheduled service network. Facility costs represent leases and operating costs for stations throughout the scheduled service network. Cost of revenue excludes depreciation and amortization. We anticipate that these costs will fluctuate in absolute dollars over time and as a percentage of revenue due to the anticipated growth of our business.

Technology and Development

Technology and development expense consists of personnel and other costs related to technology development and management efforts, including costs for third-party development resources. Technology and development efforts are focused on enhancing the ease of use and functionality of existing software platforms, as well as the development of new products and services. Technology and development costs are expensed as incurred, except to the extent that such costs are associated with internal-use software development that qualifies for capitalization. Technology and development expense excludes amortization of capitalized costs. We anticipate that these costs will fluctuate in absolute dollars over time due to the anticipated investment in software platforms.

Sales and Marketing

Sales and marketing expense consists primarily of personnel and other costs to support sales and marketing efforts. Personnel costs includes commissions, salaries and related benefits. Additionally, sales and marketing expense includes expenses associated with promotions of services, advertising and brand initiatives. We anticipate that these costs will fluctuate in absolute dollars over time and as a percentage of revenue due to the anticipated growth of our business.

General and Administrative

General and administrative expense consists of personnel-related costs for all business administrative functions. Additionally, stock-based compensation costs are included in this category for all personnel. Furthermore, professional fees, headquarter rents and other corporate related expenses are reflected in this category. We expect our general and administrative expenses to increase in absolute dollars over time and to fluctuate as a percentage of revenue due to the anticipated growth of our business and additional costs associated with being a public company.

Depreciation and Amortization

Depreciation expense consists primarily of depreciation of aircraft, aircraft parts, engines, furniture, fixtures and leasehold improvements. Amortization expense consists of amortization of capitalized software development costs, EAS contracts and brand and trademark intangibles.

Other Income/(Expense)

Other income/(expense) primarily consists of interest expense, changes in fair value of financial instruments, gain on extinguishment of debt and other non-operating costs. We expect these expenses to fluctuate in absolute dollars over time with the market or changes in timing and nature of debt costs. Certain convertible notes, SAFEs, and warrants were converted at listing and no longer require fair value measurement. The Company will continue to apply the fair value option, on an instrument by instrument basis, for similar type awards, as applicable.

Results of Operations

Results of the Company’s Operations for the Three Months Ended September 30, 2023 and 2022

The following table sets forth our condensed consolidated statements of operations data for the three months ended September 30, 2023 and 2022 (in thousands, except percentages):

Revenue

Revenue increased by $16.9 million, 332%, for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. The increase in revenue was attributable to the following changes in on-demand and scheduled revenues (in thousands, except percentages):

Scheduled revenue increased $14.6 million, or 1,461% for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. The scheduled service, absent the impacts of the acquisition of Southern, remained flat period over period.

Of the increase in scheduled revenue, $14.5 million was related to the Southern Acquisition, primarily related to EAS revenue of $7.8 million, passenger revenue of $6.0 million, and other revenue of $0.7 million in the third quarter of 2023 after the acquisition of Southern.

On-demand revenue increased by $2.3 million, or 57%, for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. The Company conducted 926 on-demand flights during the three months ended September 30, 2023, and absent the impact of the acquisition of Southern, the Company conducted 681 on-demand charter flights during the third quarter of 2023 compared to 425 on-demand charter flights during the third quarter of 2022. The increase in on-demand charter flights was driven by increases in marketing efforts for our on-demand product and service strategy growth. Price per trip decreased during the third quarter of 2023 compared to the third quarter of 2022, primarily driven by a shift in customer preference to less expensive aircraft to service charter trips in 2023. These variables accounted for roughly $1.7 million, or 74% of the total on-demand revenue increase period over period.

With the Southern Acquisition, on-demand revenue increased $0.6 million, or 26%, during the three months ended September 30, 2023, primarily from Hawaii based operations focusing on providing route services for construction crews, school events, and leisure travel.

Operating Expenses

Cost of Revenue, exclusive of depreciation and amortization

Cost of revenue increased by $14.4 million, or 232%, for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. Of the total 926 on-demand charter flights, and absent the impact of the acquisition of Southern, the Company 681 on-demand charter flights in the three months ended September 30, 2023, an increase from 425 for the three months ended September 30, 2022, resulting in a $0.8 million increase, or 6% of the total.

With the Southern Acquisition, cost of revenue increased by $13.6 million, or 95%, during the three months ended September 30, 2023 primarily due to aircraft expenses of $7.6 million, pilot expenses of $3.2 million, customer care expenses of $1.8 million, station expenses of $0.5 million, reservation systems of $0.3 million, and passenger re-accommodation expenses of $0.2 million.

Technology and Development

Technology and development expenses increased by $2.1 million, or 294%, for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. The increase was driven primarily by the amortization of software expenses related to work with Palantir for $2.0 million.

Sales and Marketing

Sales and marketing expenses increased by $3.1 million, or 228%, for the three months ended September 30, 2023, compared to the three months ended September 30, 2022, primarily due to an increase in advertising and brand awareness expenses of $1.0 million. Additionally, there was a $1.9 million increase due to management compensation and bonuses earned, as well as a continued concerted effort to grow the on-demand product offering, requiring increased sales force and related commissions, of which $1.5 million is considered non-recurring.

With the Southern Acquisition, sales and marketing expenses increased by $0.3 million primarily attributable to marketing for scheduled revenue.

General and Administrative

General and administrative expenses increased by $48.0 million, or 631%, for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. The increase in general and administrative expense is driven primarily by the recognition of an additional $32.1 million in stock-based compensation expense, of which $21.8 million is tied to the Company’s direct listing and is considered non-recurring. Additional increases were due to $6.8 million in professional and advisory fees related to the Company’s direct listing and is considered non-recurring, and $6.0 million in labor and labor-related expenses due to management compensation and bonuses earned, of which $3.1 million is considered non-recurring.

With the Southern Acquisition, general and administrative expenses increased by $3.1 million primarily attributable to labor expenses, professional fees, insurance, utilities, rent and travel.

Depreciation and Amortization

With the Southern Acquisition, depreciation and amortization expenses increased by $1.1 million, or 430%, for the three months ended September 30, 2023, compared to the three months ended September 30, 2022. This was primarily due to additional engines and aircraft parts, as well as intangibles for EAS contracts and brand name/trademarks.

Other Income/(Expense)

Other expense, net increased by $5.1 million, or 51%, for the three months ended September 30, 2023compared to the three months ended September 30, 2022. There are two primary drivers for the increase in net income/(expense).

First, there was an increase in change in fair value of financial debt instruments carried at fair value of $1.2 million, mainly driven by an increase in the fair market value of SAFE notes issued by the Company of $3.3 million, and an increase in the fair market value of derivative liabilities of $2.1 million. These increases were offset by a decrease in the change in fair market value of certain convertible notes of $4.2 million. At the end of the third quarter 2022, the fair market valuation was based on the probability of a public listing for the Company at 25%. Fair market valuations during the third quarter of 2023 were based on a higher probability of public listing and/or actual equity values.

Secondly, other income/(expenses) increased $3.0 million from the three months ended September 30, 2022 to the three months ended September 30, 2023 primarily due to a $3.2 million stock-based payment to Tuscan in full satisfaction of the termination of a business combination agreement. This was offset by $0.2 million due to decreases in financial charges and other income.

Additionally, there was an increase in interest expense of $0.4 million period over period, due to additional related party term loans.

With the Southern Acquisition, other expenses increased by $0.5 million primarily attributable to interest expense associated with the debt instruments acquired from Southern.

Net Loss

The increase in net loss of $53.8 million from the existing business for the three months ended September 30, 2022 compared to the three months ended September 30, 2023, is primarily attributable to an increase in general and administrative expenses of $45.0 million, an increase in other expenses of $4.6 million (including changes in fair market value of financial instruments, interest expense, and other expense), an increase in technology and development of $2.1 million, an increase in sales and marketing of $2.9 million, and an increase in cost of revenue of $0.8 million. These increases in expenses were offset by an increase in $1.7 million in revenue.

With the Southern Acquisition net loss decreased by $0.3 million primarily attributable to cost of revenue of $13.6 million, general and administrative expenses of $3.2 million, depreciation and amortization of $1.1 million, interest expense of $0.5 million, and marketing expenses of $0.3 million. These increases in expenses were offset by an increase of $15.3 million in revenue and $3.6 million income tax benefit.

Non-GAAP Financial Measures

The Company uses Adjusted EBITDA to identify and target operational results which is beneficial to management and investors in evaluating operational effectiveness. Adjusted EBITDA is a supplemental measure of the Company’s performance that is not required by, or presented in accordance with, U.S. GAAP. Adjusted EBITDA is not a measurement of the Company’s financial performance under U.S. GAAP and should not be considered as an alternative to net income (loss) or any other performance measure derived in accordance with U.S. GAAP. The Company’s calculation of this non-GAAP financial measure may differ from similarly titled non-GAAP measures, if any, reported by other companies. This non-GAAP financial measure should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with U.S. GAAP.

Non-GAAP financial measures have limitations in their usefulness to investors because they have no standardized meaning prescribed by GAAP and are not prepared under any comprehensive set of accounting rules or principles. In addition, non-GAAP financial measures may be calculated differently from, and therefore may not be directly comparable to, similarly titled measures used by other companies.

The Company presents Adjusted EBITDA because it considers this measure to be an important supplemental measure of its performance and believes it is frequently used by securities analysts, investors, and other interested parties in the evaluation of companies in its industry. Management believes that investors’ understanding of the Company’s performance is enhanced by including this non-GAAP financial measure as a reasonable basis for comparing its ongoing results of operations.

The Company calculates Adjusted EBITDA as net income (loss) adjusted for depreciation and amortization, interest expense, income tax expense, stock-based compensation, changes in fair value of financial instruments, gain on extinguishment of debt, transaction costs, and transaction bonuses.

The following table presents a reconciliation of Adjusted EBITDA to net loss for each of the periods indicated.

(in thousands)

44

Results of Operations

Results of the Company’s Operations for the Nine Months ended September 30, 2023 and 2022

The following table sets forth our consolidated statements of operations data for the nine months ended September 30, 2023 and 2022 (in thousands, except percentages):

Revenue

Revenue increased by $19.3 million, 134%, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. The increase in revenue was attributable to the following changes in on-demand and scheduled revenues (in thousands, except percentages):

Scheduled revenue increased by $14.0 million, or 403%, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. Absent the impact of the acquisition of Southern, the total scheduled revenue decreased by $0.6 million, or -4%, which was primarily attributable to a decline in our membership subscription base.

With the Southern Acquisition, scheduled revenue increased $14.5 million, or 104%, primarily related to EAS revenue of $7.8 million, passenger revenue of $6.0 million, and other revenue of $0.7 million in the third quarter of 2023 after the acquisition of Southern.

On-demand revenue increased by $5.3 million, or 49%, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. Of the total 1,913 on-demand charter flights, and absent the impact of the acquisition of Southern, the Company conducted 1,668 on-demand charter flights during the first nine months of 2023 compared to 1,221 on-demand charter flights during the first nine months of 2022.

The increase in on-demand charter flights was driven by increases in marketing efforts for our on-demand products and other service offerings. In addition, price per trip increased during the first nine months of 2023 compared to the first nine months of 2022, primarily driven by a shift in customer preference to more expensive aircraft to service charter trips in 2023. These variables accounted for roughly $4.7 million of the total on-demand revenue increase period over period.

With the Southern Acquisition, on-demand revenue increased by $0.6 million during the nine months ended September 30, 2023 for trips in the Hawaii based operations focusing on providing route services for construction crews, school events and leisure travel.

Operating Expenses

Cost of Revenue, exclusive of depreciation and amortization

Cost of revenue increased by $16.8 million, or 96%, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. Of the total 1,913 on-demand charter flights, absent the impact of the acquisition of Southern, the Company conducted 1,668 on-demand charter flights in the nine months ended September 30, 2023 an increase from 1,221 for the nine months ended September 30, 2022, resulted in a $3.1 million increase.

With the Southern Acquisition, cost of revenue increased by $13.6 million, or 81%, during the three months ended September 30, 2023 primarily due to aircraft expenses of $7.6 million, pilot expenses of $3.2 million, customer care expenses of $1.8 million, station expenses of $0.5 million, reservation systems of $0.3 million, and passenger re-accommodation expenses of $0.2 million.

Technology and Development

Technology and development expenses increased by $2.3 million, or 106%, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. This increase is primarily driven by the amortization of software expenses related to work with Palantir for $2.0 million in the third quarter of 2023. In addition, there was an increase in research and development costs of $0.3 million to develop hybrid-electric technology. The Company expects continued increases in expenses in order to support the development of its hybrid-electric and fully-electric powertrain technologies.

Sales and Marketing

Sales and marketing expenses increased by $4.2 million, or 115%, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. The increase in sales and marketing was primarily due to an increase in labor and labor related expenses from management compensation and bonuses earned, as well as a concerted effort to grow the on-demand product offering, requiring increased sales force and related commissions resulting in a $2.7 million increase. Additionally, increased marketing, advertising, and filming expenses related to building brand awareness of $1.2 million in the first nine months of 2023 contributed to the increase.

With the Southern Acquisition, sales and marketing expenses increased by $0.3 million primarily attributable to marketing for scheduled revenue.

General and Administrative

General and administrative expenses increased by $47.7 million, or 186%, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022. The primary drivers of the increase in general and administrative expenses were an increase in stock-based compensation expense of $24.9 million and increases in professional service fees, including audit and legal expenses related to the Company’s public listing, of $12.5 million. In addition, labor and labor related expenses due to management compensation and bonuses earned, as well as travel related expenses increased by $6.5 million and $0.5 million, respectively.

With the Southern Acquisition, general and administrative expenses increased by $3.2 million primarily attributable to labor expenses, professional fees, insurance, utilities, rent and travel.

Depreciation and Amortization

Depreciation and amortization expenses increased by $1.1 million, or 143%, for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022 primarily due to depreciation of engines and aircraft acquired from Southern, as well as intangibles for EAS contracts and brand name/trademarks.

Other Income/(Expense)

Other expense, net increased by $39.9 million, or 263%, for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 driven by an increase of $29.3 million in changes in fair value of financial instruments carried at fair value. The September 30, 2022 valuation had a public listing probability as a SPAC of 25%, whereas the September 30, 2023 valuation was based on the public market through a direct listing. This resulted in increases in change in fair value of SAFE Notes of $27.5 million, convertible notes of $6.2 million, and derivative liabilities of $8.5 million. These were offset by a decrease in fair market value of certain convertible notes of $12.8 million.

In addition, other expense increased by $3.2 million due to a stock-based payment to Tuscan Holdings in full satisfaction of the termination of a business combination agreement.

During the nine months ended September 30, 2022 there was a $6.0 million gain on extinguishment of debt due to debt facilities converted to preferred shares compared to the nine months ended September 30, 2023 which saw a loss on extinguishment of debt of $0.3 million.

Other expenses also increased for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022 due to an increase in interest expense of $1.1 million driven by $0.5 million of expense due to debt acquired from Southern and $0.6 million primarily attributable to interest expense due to higher interest rates.

Net Loss

For the total increase in net loss of $89.2 million for the nine months ended September 30, 2023 compared to the nine months ended September 30, 2022, $89.3 million of the increase is primarily due to an increase in general and administrative expenses of $44.5 million, an increase in other expenses of $39.4 million (including changes in fair market value of financial instruments, interest expense, and other expense), an increase in cost of revenue of $3.3 million, an increase in sales and marketing of $3.9 million, and an increase in technology and development of $2.3 million. These increases in expenses were offset by an increase in $4.1 million in revenue.

The net loss decreased by $0.3 million primarily attributable to cost of revenue of $13.6 million, general and administrative expenses of $3.2 million, depreciation and amortization of $1.1 million, and interest expense of $0.5 million offset by an increase in $15.3 million in revenue and a $3.6 million income tax benefit resulting from the impact of the Southern acquisition.

Adjusted EBITDA

The following table presents a reconciliation of Adjusted EBITDA to net loss for each of the periods indicated.

(in thousands)

47

Cash Flow Analysis

The following table presents a summary of our cash flows (in thousands):

Cash Flow from Operating Activities

For the nine months ended September 30, 2023, net cash used in operating activities was $45.1 million, driven by a net loss of $140 million and increases in prepaid expenses and other current assets of $3.9 million. These operating outflows were partially offset by non-cash changes in fair value of financial instruments of $49.4 million, non-cash stock-based compensation expenses of $35.4 million, increases in accounts payable and other liabilities of $15.8 million, increases in depreciation and amortization of $0.8 million, and a loss on extinguishment of debt of $0.3 million. The acquisition of Southern resulted in net cash generated by operating activities of $0.8 million. This was driven by net income of $0.3 million, increases in accounts payable and other liabilities of $0.6 million, increases in depreciation and amortization of $1.1 million, and increases in non-cash operating lease expense of $0.8 million. These were mostly offset by a $3.6 million reduction in deferred income taxes and increases in prepaid expenses and other current assets of $2.4 million.

For the nine months ended September 30, 2022, net cash used in operating activities was $22.4 million, primarily driven by a net loss of $50.5 million, and a gain on extinguishment of debt of $6.0 million. This was partially offset by $10.5 million in non-cash stock-based compensation expenses, $20.1 million in changes in fair value of financial instruments, and accounts payable and other liabilities of $3.1 million.

Net cash used in operating activities increased period over period by $22.7 million, driven by a $89.2 million increase in net loss and increases in prepaid expenses and other current assets of $6.3 million. These were partially offset by an increase of $29.4 million in non-cash changes in fair value of financial instruments, increases of $24.9 million in non-cash stock-based compensation expenses, increases of $13.8 million in accounts payable and other liabilities, a $6.3 million increase in loss on extinguishment of debt, increases of $1.1 million in depreciation and amortization, and increases of $0.7 million in non-cash operating lease expense.

Cash Flow from Investing Activities

For the nine months ended September 30, 2023, net cash used in investing activities was $11.1 million, an increase of $10.9 million compared to the nine months ended September 30, 2022, driven by 10.0 million of cash paid for aircraft deposits, $1.6 million of property and equipment costs and a settlement of long-term debt of $0.7 million. These were offset by net cash received from the acquisition of Southern of $0.7 million.

Cash Flow from Financing Activities

For the nine months ended September 30, 2023, net cash provided by financing activities was $62.1 million from proceeds from the issuance of preferred shares, ordinary shares, and exercise of share options of $28.4 million, proceeds from borrowings of SAFE and convertible notes of $11.7 million, proceeds from borrowings due to related parties of $16.4 million, and proceeds from the GEM stock purchase agreement of $4.5 million and $0.7 million due to payments on long-term debt and amounts due under finance leases acquired from Southern.

For the nine months ended September 30, 2022, net cash provided by financing activities was $22.6 million from proceeds from borrowings of SAFE and convertible notes of $19 million, proceeds from borrowings due to related parties of $2.3 million, and proceeds from issuance of preferred shares of $1.3 million.

Net cash provided by financing activities increased period over period by $39.5 million, primarily driven by proceeds from the issuance of preferred shares, ordinary shares, and exercise of share options of $28.9 million, proceeds from borrowings due to related parties of $14.1 million, proceeds from GEM stock purchase agreement of $4.5 million, offset by proceeds from borrowings of SAFE and convertible notes of $7.3 million, and payments on long-term debt of $0.6 million.

Liquidity and Capital Resources

The Company has incurred losses from operations, negative cash flows from operating activities and has a working capital deficit. The Company is currently in default of certain excise and property taxes. On May 15, 2018, the Company received a notice of a tax lien filing from the Internal Revenue Service (“IRS”) for unpaid federal excise taxes for the quarterly periods beginning October 2016 through September 2017 in the amount of $1.9 million, including penalties and interest as of the date of the notice. The Company agreed to a payment plan (“Installment Plan”) whereby the IRS would take no further action and remove such liens at the time such amounts have been paid. In 2019, the Company defaulted on the Installment Plan. Defaulting on the Installment Plan can result in the IRS nullifying such plan, placing the Company in default and taking collection action against the Company for any unpaid balance. The Company’s total outstanding federal excise tax liability including accrued penalties and interest of approximately $7.0 million is included in accrued expenses and other current liabilities on the Condensed Consolidated Balance Sheet as of September 30, 2023 and December 31, 2022. In May 2023, the Company made a payment to the IRS totaling $0.2 million. The Company intends to negotiate with the IRS to reduce the amount owed and/or apply for a revised installment plan for any amounts left remaining. The Company has also defaulted on its property tax obligations in various California counties in relation to fixed assets, plane usage and aircraft leases. The Company’s total outstanding property tax liability including penalties and interest is approximately $1.9 million as of September 30, 2023. Of the total outstanding property tax liability, $1.1 million is from a tax lien from Los Angeles County for four of the Company’s aircraft due to the outstanding liability of its 2018 through 2022 property tax returns. The Company is in the process of remediating the late filing and payment of the proper tax due. The Company also owed the city of Hawthorne, California for past due business license fees from 2018 through 2022 in the total of approximately $0.2 million as of December 31, 2022, which, as of September 30, 2023, had been paid. Also, in connection with certain past due rental and maintenance payments under its aircraft leases totaling in aggregate approximately $6.0 million, the Company has entered into a payment plan pursuant to which all repayments of the past due amounts are deferred until such time as the Company receives at least $30 million in aggregate funds in connection with any capital contribution, at which time it is required to repay $1 million of such past due payments with an additional $1 million payment due when the Company receives at least $40 million in aggregate funds, with the eventual full repayment of the remaining amounts being required upon the receipt of at least $50 million in capital contributions. As of September 30, 2023, the Company has not made any payments under this payment plan.

The Company has previously defaulted on various debt and other obligations. During 2017, the Company entered into a loan and security agreement with a commercial lender (the “Lender”), which was subsequently amended and restated in 2018 (the “2017 Term Note”). In connection with these amendments, the Company issued the Lender warrants for a total of up to 4,291,884 Surf Air ordinary shares with an exercise price of $0.01 per ordinary share and expiration dates in 2027 and 2028. In September 2018 in connection with the payment of interest on behalf of the Company, the Company issued a warrant to LamVen for a total of up to 4,447,605 Surf Air ordinary shares with an exercise price of $0.01 per ordinary share and an expiration date of September 15, 2028. On January 31, 2019, the Company defaulted on its obligation to pay the principal and accrued interest due on the 2017 Term Notes. On April 7, 2020, the Company entered into a Forbearance Agreement with the Lender, under which the Lender agreed not to exercise any remedies that it had against the Company for any event of default in 2020. On May 1, 2020, the Company further defaulted on the payment of principal and interest required under the Forbearance Agreement and on May 31, 2021, the Company entered into an amendment to the 2017 Term Note under which (1) the Lender agreed to not exercise any remedies that it had against the Company for any event of default in 2020; (2) the maturity date of the 2017 Term Note was extended to December 31, 2021 (the “New Maturity Date”), and (3) interest accrued on the unpaid principal amount of the 2017 Term Note at 12.0%. Subsequent to the New Maturity Date, the outstanding balance of the 2017 Term Note was due on demand. In connection with the 2021 amendment, the Company issued to the Lender a warrant to purchase up to 16,168,295 Surf Air ordinary shares with an exercise price of $0.01 per ordinary share and expiration date of June 9, 2031. On May 17, 2022, the 2017 Term Note was converted, via a payoff letter, into a SAFE note, allowing for the purchase of a total of $15.2 million worth of the Company’s ordinary shares following a qualifying exchange event, defined as any qualified financing, IPO, direct listing, reverse merger, or change in control. The payoff letter provides that certain security interests in the Company shall immediately terminate upon the occurrence of an exchange event and the Lender will promptly thereafter file the appropriate termination statements with respect to such security interests. The payoff letter provided the Lender, in the event that a qualifying exchange event does not occur by December 31, 2022, an option to reinstate the indebtedness under the 2017 Term that was intended to be repaid by the SAFE note. On May 24, 2023, the payoff letter was amended to extend the option to exchange to July 31, 2023. As a result of the Company’s direct listing, all amounts due under this SAFE note were settled, on contractual terms, via the issuance of shares of the Company’s common stock.

Additionally, in April 2018, the Company entered into a SAFE-T note for $500 thousand with a financial institution which the Company defaulted on in July 2019. As of December 31, 2022, the Company remained in default on this SAFE-T note. This instrument was subordinate to the Convertible Note Purchase Agreement, and therefore had no recourse prior to payment of amounts due under the Convertible Note Purchase Agreement. In addition, in May 2020, the Company entered into a 6.25% convertible note with a vendor for approximately $541,000, which was subsequently amended in September 2020 and March 2021 to increase the amount of the note to approximately $633,000. In October 2022, the Company amended the note to re-instate the $5,000 monthly payment under the terms of the note. In April 2023, the Company amended the note to extend the maturity to November 1, 2023. As a result of the Internal Reorganization, all amounts due under this note were settled, on contractual terms, via the issuance of shares of the Company’s common stock.

As of May 31, 2023, the Company was also in default in the aggregate amount of approximately $0.1 million on payments under a payment plan entered into in relation to unpaid invoices, as well as certain amounts owed under judgments related to legal proceedings and claims arising in the ordinary course of its business. During September 2023, the Company made $0.1 million in payments to cure these defaults.

The airline industry and the Company’s operations are cyclical and highly competitive. The Company’s success is largely dependent on the ability to raise debt and equity capital, achieve a high level of aircraft and crew utilization, increase flight services and the number of passengers flown, and continue to expand into regions profitably throughout the United States.

The Company’s prospects and ongoing business activities are subject to the risks and uncertainties frequently encountered by companies in new and rapidly evolving markets. Risks and uncertainties that could materially and adversely affect the Company’s business, results of operations or financial condition include, but are not limited to the ability to raise additional capital (or financing) to fund operating losses, refinance its current outstanding debt, maintain efficient aircraft utilization, primarily through the proper utilization of pilots and a managing market shortages of maintenance personnel and critical aircraft components, ,sustain ongoing operations, the ability to attract and maintain customers, the ability to integrate, manage and grow recent acquisitions and new business initiatives, obtain and maintain relevant regulatory approvals, and the ability to measure and manage risks inherent to the business model.

In addition to the risks and uncertainties associated with the Company’s emerging and legacy business models, there continues to be a worldwide impact from the COVID-19 pandemic. The impact of COVID-19 has resulted in changes in consumer and business behavior, pandemic fears, market downturns, and restrictions on business and individual activities, which created significant volatility in global economy and has led to reduced economic activity particularly in the air travel industry. Due to enhanced virtual meeting and teleconferencing technology that has been adopted throughout the COVID-19 pandemic, more people are meeting over virtual meeting platforms than in person, which reduces the need for transportation. Specifically, COVID-19 related disruption in air travel has led to a decrease in membership sales, flight cancellations and significant operational volatility contributing to the Company defaulting on certain debt arrangements and amending the terms and conditions of certain debt arrangements, in order to meet liquidity needs (see Note 10, Financing Arrangements).

Prior to the quarter ended September 30, 2023, the Company has funded its operations and capital needs primarily through the net proceeds received from the issuance of various debt instruments, convertible securities, related party funding, and preferred and common share financing arrangements. During the quarter ended September 30, 2023, the Company received $8 million under a Convertible Note Purchase Agreement with Partners for Growth V, L.P. (“PFG”), $25 million through a share purchase with GEM Global Yield LLC SCS (“GEM”) and an entity affiliated with GEM that provides incremental financing (see Note 11, Share Purchase Agreement and GEM Purchase), and $4.5 million in advances under the Share Purchase Agreement (see Note 11, Share Purchase Agreement and GEM Purchase). On November 9, 2023, the Company filed a Form S-1 registration statement with the U.S. Securities and Exchange Commission (the “SEC”) registering up to 300.0 million shares of the Company’s common stock, which represents the balance of the full amount of shares of common stock that the Company estimates could be issued and sold to GEM for advances under the Share Purchase Agreement, plus the amount of shares the Company estimates could be issued and sold to GEM for $50 million of draw-downs under the Share Purchase Agreement. The Company is subject to customary affirmative covenants and negative covenants with respect to the Convertible Note Purchase Agreement. The Company as received a waiver from PFG regarding the maintenance of minimum cash requirement of $10 million. The waiver effectively waives the requirement through February 28, 2024. As of September 30, 2023, the Company was in compliance with all other covenants under the Convertible Note Purchase Agreement.

The Company continues to evaluate strategies to obtain additional funding for future operations. These strategies may include, but are not limited to, obtaining additional equity financing, issuing additional debt or entering into other financing arrangements, restructuring of operations to grow revenues and decrease expenses. There can be no assurance that the Company will be successful in achieving its strategic plans, that new financing will be available to the Company in a timely manner or on acceptable terms, if at all. If the Company is unable to raise sufficient financing when needed or events or circumstances occur such that the Company does not meet its strategic plans or, the Company will be required to take additional measures to conserve liquidity, which could include, but not necessarily limited to, reducing certain spending, altering or scaling back development plans, including plans to equip regional airline operations with hybrid-electric or fully electric aircraft or reducing funding of capital expenditures, which would have a material adverse effect on the Company’s financial position, results of operations, cash flows, and ability to achieve its intended business objectives. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying condensed consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.

The Company’s capital expenditures in 2022 and the first nine months of 2023 were limited to payments made for aircraft supply deposits, aircraft parts, engines, immaterial purchases and internally developed software. Upon the Company’s ability to utilize the Share Purchase Agreement or obtain alternative funding, the Company intends to invest significantly in expansion of its network footprint and in development of electrified powertrain technology and its commercial platform. Expansion of the network will require acquisition of aircraft over the next five years with an expected cost of approximately $1.2 billion. The Company has placed an order with TAI for 100 Cessna Grand Caravan aircraft with an option for an additional 50 Cessna Grand Caravan aircraft, with expected delivery taken over the next five years. As of September 30, 2023, the Company has made deposits of $10.0 million for aircraft that are scheduled to be delivered starting in Q2 2024. The Company intends to finance these aircraft through Jetstream Aviation Capital, with which the Company currently has a sale-leaseback financing arrangement of up to $450 million, and additional debt facilities that it intends to obtain. See the section entitled “Risk Factors — Risks Related to SAM’s Financial Position and Capital Requirements — SAM has no operating history. Surf Air and Southern’s past financial results may not be a reliable indicator of SAM’s future success” included within the Registration Statement. The Company has engaged AeroTEC to develop hybrid-electric and fully electric STCs for the Cessna Grand Caravan in partnership with TAI. A portion of these costs are expected to be funded through the Share Purchase Agreement.

Commitments

The Company has entered into various contractual arrangements related to the build-out of the Company’s air service fleet, the development of its proprietary hybrid and electric aircraft technology, and the build out of its aircraft as a service platform. These arrangements include commitments for payments pursuant to licensing agreements, which routinely contain provisions for guarantees or minimum expenditures during the terms of the contracts. The Company also enters into long-term debt arrangements that include periodic interest and principal payments. Additionally, the Company routinely enters into noncancelable lease agreements for aircraft and operating locations, which contain minimum rental payments.

The following table summarizes the Company’s contractual commitments and obligations (in thousands) :

Critical Accounting Policies and Estimates

The consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

Use of Estimates

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of income and expense during the reported period.

Our management believes that the accounting estimates listed below are those that are most critical to the portrayal of our financial condition and results of operations, and that require management’s most difficult, subjective and complex judgments in estimating the effect of inherent uncertainties.

Stock-Based Compensation

We grant stock options, restricted stock units (“RSUs”) and performance-based restricted stock units (“PRSUs”) to certain employees, as well as non-employees (including directors and others who provide services to us) under our stock plans. We recognize compensation expense resulting from stock-based payments over the period for which the requisite services are provided.

Stock Options

We use the Black-Scholes option pricing model to estimate the fair value of the stock options at the measurement date. The grant date is deemed to be the appropriate measurement date for stock options issued to employees and non-employees. We have elected to account for forfeitures as they occur.

The use of the Black-Scholes option pricing model requires the use of subjective assumptions, including the following:

• ***Fair Value of Common Stock—***Prior to the Company’s direct listing, the absence of an active market for our common stock required us to estimate the fair value of our common stock. See the subsection titled “Common Stock Valuations” below. For valuations completed subsequent to the direct listing, the fair value of each share of underlying common stock is based on the closing price of our common stock as reported on the date immediately preceding the date of grant.
• ***Risk-Free Interest Rate—***The yield on actively traded non-inflation indexed U.S. Treasury notes with the same maturity as the expected term of the underlying options was used as the average risk-free interest rate.
• ***Expected Term—***The expected term of options granted to employees was determined based on management’s expectations of the options granted, which are expected to remain outstanding. Where appropriate, we calculated the expected term using the simplified method for “plain vanilla” stock option awards.
• ***Expected Volatility—***Given our limited trading history subsequent to the direct listing, there is limited substantive share price history to calculate volatility and, as such, we have elected to use an approximation based on the volatility of other comparable public companies, which compete directly with us, over the expected term of the options.
• ***Dividend Yield—***We have not issued regular dividends on common shares in the past nor do we expect to issue dividends in the future. As such, the dividend yield has been estimated to be zero.

We will continue to use judgment in evaluating the expected volatility and expected terms utilized in our stock-based compensation expense calculations on a prospective basis. As we continue to accumulate additional data related to our common stock, we may refine our estimates, which could materially impact our future stock-based compensation expense. Additionally, had we arrived at different assumptions of stock price volatility or expected lives of our stock options, our stock-based compensation expense and results of operations may be materially different.

Restricted Stock Units

The fair value of RSUs is estimated based on the fair value of our common stock on the grant date. Estimating the grant date fair value of the common stock underlying RSU grants prior to our direct listing was highly judgmental due to the lack of an observable market for our common stock. Prior to our direct listing, the fair value of the Company’s common stock was determined by considering a number of objective and subjective factors including: contemporaneous third-party valuations of our common stock, sales of our redeemable convertible preferred stock to outside investors in arms-length transactions, the Company’s operating and financial performance, the lack of marketability, and the general and industry-specific economic outlook, amongst other factors. Estimating the grant date fair value of the RSUs, including the PSUs discussed below, was highly sensitive due to the volume of RSUs granted and increasing fair value of our common stock as we approached our direct listing. For RSUs granted prior June 30, 2023, all awards were deemed to have vested upon the satisfaction of both a service-based vesting condition and a liquidity event-related performance vesting condition tied to the direct listing.

Subsequent to our direct listing, the fair value of our RSUs will be based on the stock price on the day immediately preceding the date of grant, there will no longer be a level of judgment involved that could impact the fair value of the RSUs or expense incurred.

Performance-Based Restricted Stock Units

In July 2023, we granted PRSUs to each of our three founders (“Founder PRSUs”). The Founder PRSUs vest upon the satisfaction of a service condition and the achievement of certain stock price goals. We estimated the grant date fair value of the Founder PRSUs using a model based on multiple stock price paths developed through the use of a Monte Carlo simulation that incorporates into the valuation the possibility that the stock price goals may not be satisfied. A Monte Carlo simulation model requires the use of various assumptions, including the underlying stock price, volatility, expiration term, and the risk-free interest rate as of the valuation date, corresponding to the length of time remaining in the performance period, and expected dividend yield. The derived service period calculation also requires the cost of equity assumption to be used in the Monte Carlo simulation model. Term and volatility are typically the primary drivers of this valuation. The average grant date fair value of the Founder PRSUs were estimated to be $2.26 per share, and we will recognize total stock-based compensation expense of approximately $6.3 million over the derived service period. If the stock price goals are met sooner than the derived service period, we will adjust our stock-based compensation expense to reflect the cumulative expense associated with the vested award. Provided that each founder individually stays employed with the Company, we will recognize stock-based compensation expense over the requisite service period, regardless of whether the stock price goals are achieved. Had we arrived at different assumptions of underlying stock price or volatility our stock-based compensation expense and results of operations may be materially different.

Common Stock Valuations

Prior to our direct listing, given the absence of a public trading market for our common stock, and in accordance with the American Institute of Certified Public Accountants Accounting and Valuation Guide, Valuation of Privately-Held Company Equity Securities Issued as Compensation (the “Practice Aid”), our board of directors exercised its reasonable judgment and considered numerous objective and subjective factors to determine the best estimate of fair value of our common stock, including:

• independent third-party valuations of our common stock;
• the prices at which we sold shares of our preferred stock;
• the rights, preferences and privileges of our preferred stock relative to those of our common stock;
• our capital resources and financial condition;
• the likelihood and timing of achieving a liquidity event, such as an initial public offering or sale of the company, given prevailing market conditions;
• our historical operating and financial performance as well as our estimates of future financial performance;
• valuations of comparable companies;
• the hiring of key personnel;
• the relative lack of marketability of our common stock;
• industry information such as market growth and volume and macro-economic events; and

additional objective and subjective factors relating to our business.

The Practice Aid identifies various available methods for allocating enterprise value across classes and series of capital stock to determine the estimated fair value of common stock at each valuation date.

In accordance with the Practice Aid, for our historical valuations performed, we concluded the Hybrid Method was the most appropriate method for determining the fair value of our common stock given our stage of development and other relevant factors. The Hybrid Method is a scenario-based analysis that estimates value per share based on the probability-weighted present value of expected future financing events, considering each of the possible outcomes available to us, as well as the economic and control rights of each share class.

The assumptions underlying these valuations represent our board of directors’ best estimates at the time they were made, which involve inherent uncertainties and the application of the judgment of our board of directors. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our stock-based compensation expense could be materially different.

Subsequent to the direct listing, the fair market value of our common stock based on its closing price as reported on the date of grant on the New York Stock Exchange.

Fair Value Measurements

The Company has a significant number of debt and equity transactions that are recorded at fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The assumptions used in the Company’s valuation models represent management’s best estimates. These estimates involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, the Company’s results could reflect material fluctuation in Changes in fair value of financial instruments carried at fair value, net on the Consolidated Statement of Operations.

Fair value measurements are based on a fair value hierarchy, based on three levels of inputs, of which the first two are considered observable and the last unobservable, which are the following:

Assets and liabilities are classified in the hierarchy based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy.

The Company measures the fair value of certain long-lived assets including finite-lived intangible assets on a nonrecurring basis, when such assets are required to be written down to fair value if impaired. Such fair values are classified within Level 3 of the fair value hierarchy, as the valuations contain significant unobservable inputs, including assumptions of the present value of future cash flows, the use of these assets, as well as estimated disposition value.

The Company’s convertible securities and Simple Agreements for Future Equity (“SAFE”) notes are carried at fair value. SAFE notes are financial instruments whereby an investor provides an investment into the Company, and the note is subsequently converted into a preferred equity security at a discount to the price paid by other investors when and if a preferred equity is issued through a qualifying capital raise. Due to certain provisions included in the agreements for these instruments, they are classified as liabilities. Additionally, the Company elected the fair value option for certain convertible notes and SAFE notes, which requires them to be remeasured to fair value each period. If factors change and different assumptions are used, the Company’s results could reflect material fluctuation in Changes in fair value of financial instruments carried at fair value, net on the Consolidated Statements of Operations. As a result of the Internal Reorganization and settlements of SAFE notes as part of the Company’s direct listing, these balances have been significantly reduced at of September 30, 2023.

Income Taxes

The determination of tax strategies and positions, along with accounting for related income taxes requires interpretation of various federal and state tax policies and assessment of the likelihood of various outcomes. Management believes that accounting for income taxes requires difficult, subjective and complex judgments and defenses. Income taxes are accounted for under the asset and liability method in accordance with U.S. GAAP. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statements carrying amounts of existing assets and liabilities and their respective tax bases and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The likelihood of realizing the tax benefits related to a potential deferred tax asset is evaluated, and a valuation allowance is recognized to reduce that deferred tax asset if it is more likely than not that all or some portion of the deferred tax asset will not be realized.

Deferred tax assets and liabilities are calculated at the beginning and end of the period. The change in the sum of the deferred tax asset, valuation allowance and deferred tax liability during the period generally is recognized as a deferred tax expense or benefit. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date.

The Company determines whether a tax position taken or expected to be taken in a tax return is to be recognized in the consolidated financial statements when it is more likely than not, based on the technical merits, that the position will be sustained upon examination. The amount recognized is subject to estimation and management judgment with respect to the likely outcome of each uncertain tax position. The amount that is ultimately sustained for an individual uncertain tax position or for all uncertain tax positions in the aggregate could differ from the amount recognized. For tax positions meeting the more likely than not threshold, the tax amount recognized in the consolidated financial statements is reduced by the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority. Surf Air recognizes interest and penalties accrued related to unrecognized tax benefits, if any, in its income tax expense in the accompanying Consolidated Statement of Operations.

JOBS Act

The Company currently qualifies as an “emerging growth company” under the JOBS Act. Accordingly, the Company has elected to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. The Company’s utilization of these transition periods may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the transition periods afforded under the JOBS Act.

In the ordinary course of operating our business, we are exposed to market risks. Market risk represents the risk of loss that may impact our financial position or results of operations due to adverse changes in financial market prices and rates. Our principal market risks have related to interest rates and aircraft fuel. Refer to the information included in the section entitled “Risk Factors” in the Company’s Registration Statement as well as in “Item 1A Risk Factors” in this Report.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act of 1934, as amended (the “Exchange Act”)), that are designed to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, to allow for timely decisions regarding required disclosure. It should be noted that, because of inherent limitations, our disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the disclosure controls and procedures are met.

As required by Rule 13a-15(b) under the Exchange Act, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2023. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective at a reasonable assurance level as of September 30, 2023, due to presence of the material weaknesses in internal control over financial reporting described below.

Notwithstanding the pending remediation efforts described below, based on additional analysis and other post-closing procedures performed, our management believes that the financial statements included in this report present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with U.S. GAAP

Material Weaknesses in Internal Control Over Financial Reporting

As of September 30, 2023, material weaknesses existed in our internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses are as follows:

• We did not design and maintain an effective control environment commensurate with our financial reporting requirements. Specifically, we lacked a sufficient complement of resources with (i) an appropriate level of accounting knowledge, training and experience to appropriately analyze, record and disclose accounting matters timely and accurately, and (ii) an appropriate level of knowledge and experience to establish effective processes and controls. Additionally, the lack of a sufficient complement of resources resulted in an inability to consistently establish appropriate authorities and responsibilities in pursuit of our financial reporting objectives, as demonstrated by, among other things, insufficient segregation of duties in our finance and accounting functions.
• We did not design and maintain effective controls in response to the risks of material misstatement. Specifically, changes to existing controls or the implementation of new controls have not been sufficient to respond to changes to the risks of material misstatement to financial reporting.

These material weaknesses contributed to the following additional material weaknesses:

• We did not design and maintain effective controls related to the identification of and accounting for certain non-routine, unusual or complex transactions, including the proper application of U.S. GAAP of such transactions. Specifically, we did not design and maintain effective controls to timely identify and account for capitalizable costs, revenue, stock-based compensation, and debt and equity financing transactions.
• We did not design and maintain effective controls related to the period-end financial reporting process, including designing and maintaining formal accounting policies, procedures and controls to achieve complete, accurate and timely financial accounting, reporting and disclosures. Additionally, we did not design and maintain effective controls over the preparation and review of account reconciliations and journal entries, including maintaining appropriate segregation of duties.
• We did not design and maintain effective information technology (“IT”) general controls for information systems that are relevant to the preparation of our financial statements. Specifically, we did not design and maintain: (i) program change management controls to ensure that program and data changes are identified, tested, authorized, and implemented appropriately; (ii) user access controls to ensure appropriate segregation of duties and to adequately restrict user and privileged access to appropriate personnel; (iii) computer operations controls to ensure that processing and transfer of data, and data backups and recovery are monitored; and (iv) program development controls to ensure that new software development is tested, authorized and implemented appropriately.

These material weaknesses resulted in audit adjustments to substantially all of our accounts, which were recorded prior to the issuance of the consolidated financial statements as of December 31, 2021 and 2020 and for the years then ended, and as of June 30, 2022 and 2021 and for the six-month periods then ended. Subsequently, those material weaknesses also resulted in misstatements to accrued expenses, additional paid-in capital and stock-based compensation expense to the consolidated financial statements as of December 31, 2022 and for the year then ended. Additionally, these material weaknesses could result in a misstatement of substantially all of our accounts or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.

Additionally, with the closing of the Southern Acquisition, and the continued integration of associated operations and processes into those of the Company, the following material weakness in internal control over financial reporting has also been identified, after considering alignment with previous material weaknesses identified and outlined above:

• We did not design and maintain effective controls to achieve complete, accurate and timely accounting for debt, deferred liabilities, leases, property and equipment, redeemable convertible preferred shares, accounts payable, and accrued liabilities. This material weakness did not result in adjustments to our consolidated financial statements. However, this material weakness could result in a misstatement of the aforementioned accounts or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected.

Additionally, prior to our acquisition of Southern, Southern reported multiple material weaknesses related to control environment, risks of material misstatement, period-end financial reporting and IT general controls in our Form S-1 filed on September 19, 2023.Those material weaknesses resulted in audit adjustments to substantially all of Southern’s accounts, which were recorded prior to the issuance of the consolidated financial statements of Southern as of December 31, 2022, 2021 and 2020 and for the years then ended. Subsequently, those material weaknesses also resulted in a revision to the previously issued consolidated financial statements of Southern as of December 31, 2022 and 2021 and for the years then ended, and the interim periods ended June 30, 2022 and 2021, to correct for errors in revenues and deferred revenues. Also, in connection with the preparation of Southern’s financial statements for the interim period ended March 31, 2023, Southern identified an error related to the accounting for prepaid passenger ticket deposits. Southern’s management determined that this error was the result of the previously reported material weaknesses. This error was corrected in Southern’s financial statements as of December 31, 2022 and 2021 and for the years then ended and the interim periods ended June 30, 2022 and 2021 as a revision to previously issued financial statements.

Remediation Plans to Address Material Weaknesses

To date, we have developed a plan to address the material weaknesses identified above. This remediation plan consists primarily of: (i) adding key personnel to strengthen the Company’s financial reporting processes, (ii) improving our internal controls around financial systems and processes, (iii) formalizing internal controls related to the identification of and accounting for certain non-routine, unusual or complex transactions, including the proper application of U.S. GAAP to such transactions, (iv) engaging a third party to assist in identifying risks of material misstatement and designing and implementing controls to address the identified risks of material misstatement. and (v) designing and operating computer operations, program and system development, and user access and change management controls. We intend to take additional steps to remediate the deficiencies identified above and further evolve our internal controls and processes.

Changes in Internal Control over Financial Reporting

Due to the acquisition of Southern, there were changes in our internal control over financial reporting identified in connection with the evaluation required by Rules 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. We are currently in the process of integrating Southern’s operations, control processes and information systems into our systems and control environment.

Inherent Limitation on the Effectiveness of Internal Control over Financial Reporting and Disclosure Controls and Procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected or preventable.

As of the date of this Quarterly Report, there have been no material changes with respect to those risk factors previously described in our Registration Statement on Form S-1, filed on November 9, 2023 (File No. 333-275434). Any of these factors could result in a significant or material adverse effect on our results of operations or financial condition. Additional risk factors not presently known to us or that we currently deem immaterial may also impair our business or results of operations.