**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-K**

 

**(Mark One)**

x        ANNUAL REPORT PURSUANT TO SECTION 13 OR15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**For thefiscal year ended March 31, 2006**

**or**

 

o         TRANSITION REPORT PURSUANT TO SECTION13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

**For thetransition period from          to             **

 

**CommissionFile No. 0-17895**

 

**MAIR HOLDINGS, INC.**

(Exactname of registrant as specified in its charter)

 

| **Minnesota**                                                   | **41-1616499**                        |
|-----------------------------------------------------------------|---------------------------------------|
| (State  or other jurisdiction of incorporation or organization) | (I.R.S.  Employer Identification No.) |

 

**150South Fifth Street, Suite 1360**

**Minneapolis,Minnesota  55402**

(Addressof principal executive offices) (Zip Code)

 

Registrant’stelephone number, including area code:  **(612) 333-0021**

Securitiesregistered pursuant to Section 12(b) of the Act:  **None**

Securitiesregistered pursuant to Section 12(g) of the Act:  **Common Stock, par value$.01 per share**

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes  o     No  x

 

Indicate by check mark if the registrant isnot required to file reports pursuant to Section 13 or Section 15(d) of theAct.

 

Yes  o     No  x

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days.  Yes  x     No o

 

Indicate by check mark if disclosure ofdelinquent filers pursuant to Item 405 of Regulation S-K is not containedherein, and will not be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in PartIII of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, or a non-acceleratedfiler.  See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

 
| Large accelerated filer o |   | Accelerated  filer x |   | Non-accelerated  filer o |
|---------------------------|--------|----------------------|--------|--------------------------|

 

Indicate by check mark whether the registrantis a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o     No  x

 

The aggregate market value of the voting stockheld by non-affiliates as of September 30, 2005 was $63 million.

 

As of June 1, 2006, there were 20,591,840shares of the registrant’s Common Stock outstanding.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

Portions of the definitive Proxy statement forthe registrant’s 2006 Annual Meeting of Shareholders are incorporated byreference into the Part III Items 10, 11, 12, 13 and 14 of this Form 10-K.

 

 

 

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**MAIRHOLDINGS, INC.**

**AnnualReport on Form 10-K**

**For the Fiscal Year Ended March31, 2006**

 

**TABLEOF CONTENTS**

 
| **CAUTIONARY NOTE REGARDING  FORWARD-LOOKING STATEMENTS**                                                 | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                | ** ** |
| **PART I**                                                                                                | ** ** |
| ** **                                                                                                | ** ** |
| ITEM  1. BUSINESS                                                                                         |       |
| ITEM  1A. RISK FACTORS                                                                                    |       |
| ITEM 1B. UNRESOLVED  STAFF COMMENTS                                                                       |       |
| ITEM 2. PROPERTIES                                                                                        |       |
| ITEM 3. LEGAL PROCEEDINGS                                                                                 |       |
| ITEM 4. SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                              |       |
| EXECUTIVE OFFICERS  OF THE REGISTRANT                                                                     |       |
|                                                                                                      |       |
| **PART  II**                                                                                              | ** ** |
| ** **                                                                                                | ** ** |
| ITEM 5. MARKET  FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS                       |       |
| ITEM 6. SELECTED FINANCIAL  DATA                                                                          |       |
| ITEM 7. MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS       |       |
| ITEM 7A. QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                      |       |
| ITEM 8. FINANCIAL  STATEMENTS AND SUPPLEMENTAL DATA                                                       |       |
| ITEM 9. CHANGES  IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE             |       |
| ITEM 9A. CONTROLS  AND PROCEDURES                                                                         |       |
| ITEM 9B. OTHER INFORMATION                                                                                |       |
|                                                                                                      |       |
| **PART III**                                                                                              | ** ** |
| ** **                                                                                                | ** ** |
| ITEM 10. DIRECTORS  AND EXECUTIVE OFFICERS OF THE REGISTRANT                                              |       |
| ITEM 11. EXECUTIVE  COMPENSATION                                                                          |       |
| ITEM 12. SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER  MATTERS |       |
| ITEM 13. CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS                                                  |       |
| ITEM 14. PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                          |       |
|                                                                                                      |       |
| **PART  IV**                                                                                              | ** ** |
| ** **                                                                                                | ** ** |
| ITEM 15. EXHIBITS  AND FINANCIAL STATEMENT SCHEDULES                                                      |       |
|                                                                                                      |       |
| **SIGNATURES**                                                                                            | ** ** |
| ** **                                                                                                | ** ** |
| **EXHIBIT INDEX**                                                                                         | ** ** |

 

 

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# **CAUTIONARY NOTE REGARDING FORWARD-LOOKINGSTATEMENTS**

 

Statements in this Annual Report on Form 10-Kof MAIR Holdings, Inc. (“Holdings” or the “Company”) under the caption “Business”and “Management’s Discussion and Analysis of Financial Condition and Results ofOperations” and elsewhere in this report are forward-looking and are based uponinformation currently available to the Company. The Company, through its officers, directors or employees, may also fromtime to time make oral forward-looking statements.  In connection with the “safe harbor”provisions of the Private Securities Litigation Reform Act of 1995, the Companyis hereby identifying important factors that could cause actual results todiffer materially from those contained in any forward-looking statement made byor on behalf of the Company.  Manyimportant factors that could cause such a difference, including thosesurrounding Mesaba Aviation, Inc.’s bankruptcy proceedings, are described in “Item1A.  Risk Factors” in this Annual Reporton Form 10-K.

 

Undue reliance should not be placed on theCompany’s forward-looking statements because the matters they describe aresubject to known and unknown risks, uncertainties and other unpredictablefactors, many of which are beyond the Company’s control.  The Company’s forward-looking statements arebased on the information currently available and speak only as of the date onwhich this report was filed with the United States Securities and ExchangeCommission (“SEC”).  Over time, actualresults, performance or achievements will likely differ from the anticipatedresults, performance or achievements that are expressed or implied by theCompany’s forward-looking statements, and such differences might be significantand materially adverse to the Company’s shareholders.

 

All subsequent written or oralforward-looking statements attributable to the Company or persons acting on theCompany’s behalf are expressly qualified by the factors described above.  The Company assumes no obligation, and disclaimsany obligation, to update information contained in this Annual Report on Form10-K, including forward-looking statements, as a result of facts, events orcircumstances after the date of this report, except as required by law in thenormal course of its public disclosure practices.

 

 

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# **PART I**

 

## ***Item1.  BUSINESS***

 

MAIR Holdings, Inc. (“Holdings” or the “Company”)is the holding company for Mesaba Aviation, Inc., a regional air carrier basedin Minneapolis, Minnesota (“Mesaba”) and Big Sky Transportation Co., a regionalair carrier based in Billings, Montana (“Big Sky”).  Mesaba and Big Sky are each wholly-ownedsubsidiaries of Holdings.  The financialposition and results of operations of Mesaba were deconsolidated from theCompany’s consolidated financial statements effective October 13, 2005, thedate Mesaba filed for bankruptcy protection. Mesaba and Big Sky are the Company’s reportable segments that aremanaged independently.  Additional detailon segment reporting is included in “Item 8. Financial Statements and Supplemental Data, Note 13 — SegmentInformation” in this Annual Report on Form 10-K.

 

**Operations**

 

*Mesaba*

MesabaBankruptcy

On October 13, 2005 (the “Petition Date”),Mesaba voluntarily filed in the United States Bankruptcy Court for the Districtof Minnesota (the “Bankruptcy Court”) for bankruptcy protection under Chapter11 of the United States Bankruptcy Code. Mesaba’s bankruptcy filing was a direct result of events leading up toand following the bankruptcy filing by Northwest Airlines, Inc. (“Northwest”)on September 14, 2005.  Northwest isMesaba’s major customer, and as a result of Northwest’s missed payments toMesaba before and after Northwest’s bankruptcy filing, Mesaba estimates thatNorthwest owes Mesaba approximately $29.1 million as of March 31, 2006 underthe various agreements between the parties, net of amounts that Mesaba owed toNorthwest under these agreements. Northwest has also proposed and made several significant fleet changesthat have resulted in Mesaba operating a substantially reduced fleet.

 

Northwest’s missed payments to Mesaba andNorthwest’s actions regarding its fleet and schedule changes adversely affectedMesaba, and Mesaba determined that it could not sustain its operations outsideof court protection under Chapter 11 of the Bankruptcy Code.  Since the Petition Date, Mesaba hascontinued, and will continue, to operate its business as a debtor-in-possessionunder the jurisdiction of the Bankruptcy Court and in accordance with theapplicable provisions of the Bankruptcy Code, the Federal Rules of BankruptcyProcedure and applicable court orders. In general, as a debtor-in-possession, Mesaba is authorized underChapter 11 to continue to operate as an ongoing business, but may not engage intransactions outside the ordinary course of business without the prior approvalof the Bankruptcy Court.  All of Mesaba’svendors are being paid for all goods furnished and services provided to Mesabaafter the Petition Date in the ordinary course of business.  However, under Section 362 of the BankruptcyCode, actions to collect most of Mesaba’s prepetition liabilities areautomatically stayed.

 

Mesaba intends to utilize the Chapter 11process to reorganize its business and emerge as a competitive and profitablesupplier of regional flights.  Mesaba’smajor goals to be realized through the Chapter 11 process include:

 

•                  restructuringits costs to realize savings, including both labor and non-labor contractsrelated to its operations;

•                  “right-sizing”its workforce and overhead to account for Mesaba’s reduced fleet; and

•                  affirmingMesaba’s relationship with Northwest.

 

 

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Mesaba has taken many actions to achievethese goals, several of which are discussed in more detail below.  Mesaba must ultimately confirm a plan ofreorganization to successfully emerge from bankruptcy.  Mesaba will continue to refine its Chapter 11goals as it deems necessary to respond to changing conditions.

 

As provided by the Bankruptcy Code, onNovember 2, 2005, the United States Trustee for the District of Minnesotaappointed an Official Committee of Unsecured Creditors (the “Creditors’Committee”). The Creditors’ Committee and its legal representatives have aright to be heard on all matters that come before the Bankruptcy Courtconcerning Mesaba’s reorganization. There can be no assurance that theCreditors’ Committee will support Mesaba’s positions or plan of reorganization.

 

Under Section 365 of the Bankruptcy Code,Mesaba may assume, assume and assign, or reject certain executory contracts andunexpired leases, including leases of real property, subject to the approval ofthe Bankruptcy Court and certain other conditions.  In general, if Mesaba rejects an executorycontract or unexpired lease, it is treated as a prepetition breach of the leaseor contract in question and, subject to certain exceptions, relieves Mesaba ofperforming any future obligations. However, such a rejection entitles the lessor or contract counterpartyto a prepetition general unsecured claim for damages caused by such deemedbreach and, accordingly, the counterparty may file a claim against Mesaba forsuch damages.  Mesaba’s original Section365 deadline related to real estate leases was December 12, 2005.  On June 6, 2006, the Bankruptcy Courtextended the Section 365 deadline to the earlier of confirmation of areorganization plan or December 10, 2006.

 

Mesaba’s rights relative to certain leases,particularly aircraft and aircraft-related leases, are governed by Section 1110of the Bankruptcy Code.  Section 1110provides a 60 day deadline from the date of filing for bankruptcy by which,absent agreement with the other party or authorization by the Bankruptcy Court,Mesaba must take action with respect to such lease, after which the applicablelessor’s, sublessor’s, secured party’s or vendor’s right to take possession ofthe relevant equipment and to enforce its rights is not limited or affected bythe automatic stay provision of the Bankruptcy Code.  Northwest and Mesaba initially agreed toextend the deadline with respect to aircraft Mesaba leases or subleases fromNorthwest.  Although that agreementexpired as of February 15, 2006, Mesaba continues to use the aircraft inaccordance with Northwest’s scheduling requests and is performing under thesubleases for all aircraft that have not been idled at Northwest’srequest.  Because the aircraft currentlyoperated by Mesaba are subleased from Northwest, Mesaba’s decisions withrespect to such aircraft will be timed with Northwest’s fleet plan decisionsmade during Northwest’s bankruptcy.

 

Mesaba’s estimate of its liability forprepetition general unsecured claims is reflected in Mesaba’s “liabilitiessubject to compromise.”  Mesaba’s deconsolidatedbalance sheet at March 31, 2006 includes $60.0 million in liabilities subjectto compromise.  See “Item 8. FinancialStatements and Supplemental Data, Note 20 — Financial Information of Mesaba”for additional information.  Mesabaexpects its liabilities subject to compromise to change in the future as aresult of future negotiations with creditors or damage claims created by Mesaba’srejection of various aircraft leases, executory contracts and unexpiredleases.  Generally, if Mesaba assumes anaircraft financing agreement, executory contract or unexpired lease, Mesaba isrequired to provide for a cure for existing defaults under such contract orlease as a condition to such assumption.

 

Section 1113 of the Bankruptcy Code providesthat a debtor may reject its collective bargaining agreements (“CBAs”) if thedebtor first satisfies various statutory requirements and obtains theBankruptcy Court’s approval of such rejection. Mesaba commenced Section 1113 proceedings with all four of its unions,and on January 31, 2006, the Bankruptcy Court approved Mesaba’s tentativeagreement reached with the Transport Workers’ Union (“TWU”).  The Bankruptcy Court heard testimony from 

 

 

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Mesaba and the remaining three unions forMesaba’s pilots, mechanics and flight attendants in February and March2006.  On May 18, 2006, the BankruptcyCourt denied Mesaba’s motion to reject. Although the Bankruptcy Court agreed with Mesaba’s core businessassumptions, the court ruled that Mesaba failed to satisfy certain technicalelements required to authorize rejection of the labor contracts under Section1113.  The Bankruptcy Court stated thatif Mesaba chooses to remedy the defects in its original motion, the court wouldhear a renewed motion in a prompt manner. On June 12, 2006, Mesaba filed a renewed motion for authority to rejectits CBAs, and the Bankruptcy Court began hearing the motion on June 26,2006.  There can be no assurance thatMesaba will ultimately obtain the labor cost savings it requires tosuccessfully reorganize.

 

Pursuant to Mesaba’s request fordebtor-in-possession financing, in October 2005, Holdings provided a commitmentletter and term sheet to Mesaba for such financing.  At Mesaba’s request, Holdings extended thedeadline for the expiration of the commitment letter two times.  On March 24, 2006, the commitmentexpired.  Mesaba is seekingdebtor-in-possession financing from other sources, but there can be noassurance that Mesaba will be able to obtain such financing on acceptableterms.  If Mesaba is unable to obtaindebtor-in-possession financing by the end of the second quarter of fiscal 2007,Mesaba may not have sufficient cash to continue to fund its operations.

 

To successfully emerge from Chapter 11, theBankruptcy Court must confirm a plan of reorganization, the filing of whichwill depend on the timing and outcome of numerous ongoing matters in theChapter 11 process, potentially including the outcome of Northwest’s Chapter 11case.  The reorganization plan will besubject to a vote by certain classes of creditors, including Mesaba’s securedcreditors and unsecured creditors.  TheBankruptcy Court will generally not approve a reorganization plan unless allimpaired classes of creditors vote to accept the plan; however, Mesaba mayelect to invoke certain provisions of the Bankruptcy Code in order to obtainconfirmation of the plan over the vote of a dissenting class of creditors.  In addition to the voting requirements forconfirmation, Mesaba will have to satisfy other provisions of the BankruptcyCode in order to confirm its reorganization plan, including showing that theplan is feasible.  Additionally, theabsolute priority rule in the Bankruptcy Code requires that all of the debtor’screditors must be paid in full; otherwise the equity holders in the debtor arenot entitled to retain their equity interests, unless certain exceptions to theabsolute priority rule are met.

 

Mesaba had the exclusive right for 120 daysfrom the Petition Date to file a plan of reorganization, followed by 60 days inwhich to obtain acceptance of the plan. On March 9, 2006, the Bankruptcy Court approved a motion filed by Mesabato extend the deadline for Mesaba’s exclusive right to file such a plan toAugust 10, 2006.  Mesaba intends to filea plan of reorganization as soon as it is able, but there can be no assurancethat a reorganization plan will be proposed by Mesaba within the required timeframe or that any additional extensions Mesaba may request will be approved.  Additionally, there can be no assurance thatthe Bankruptcy Court will confirm any plan of reorganization proposed by Mesabaor that any such plan will be implemented successfully.  The reorganization plan will determine therights and claims of various creditors and security holders.  At this time, it is not possible to predictaccurately the effect of the Chapter 11 reorganization process on Mesaba’sbusiness, nor can Mesaba make any predictions concerning how the variouscreditor claims and interests of security holders will be determined in thebankruptcy proceedings.

 

MesabaOperations

Mesaba operates as a regional air carrierproviding scheduled passenger service as “Mesaba Airlines/Northwest Airlink”and “Mesaba Airlines/Northwest Jet Airlink” for Northwest.  As discussed above, both Northwest and Mesabafiled for Chapter 11 bankruptcy protection on September 14, 2005 and October13, 2005, respectively.  Mesaba’srelationship with Northwest is governed by the Airline Services Agreement (the “ASA”)dated August 29, 2005.  Prior to the ASA,Mesaba provided regional airline services to Northwest pursuant to two separateagreements, an Airline Services Agreement (the 

 

 

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“Airlink Agreement”) that governed Mesaba’soperation of Saab 340 jet-prop aircraft (“Saabs”), and a Regional Jet ServicesAgreement (the “Jet Agreement”) that governed Mesaba’s operation of Avro RJ85regional jets (“Avros”).  The ASA is aten-year omnibus agreement that incorporates the existing payment terms for theSaabs and Avros contained in the Airlink Agreement and the Jet Agreement, andadds new payment terms for the Canadair regional jets (“CRJs”) that Mesababegan operating in October 2005.  As ofMarch 31, 2006, Mesaba served 102 cities in the United States and Canada fromNorthwest’s hub airports located in Minneapolis/St. Paul, Detroit and Memphis.

 

Northwest purchases Mesaba’s entire capacityand pays Mesaba in arrears on the 11th and 26th of each month for regional airline services thatMesaba provides to Northwest utilizing the Saabs and Avros.  Beginning in October 2005, Northwest beganpaying Mesaba, on a regular bi-monthly basis, on the 1st and 16th of each month for regionalairline services that Mesaba provides to Northwest utilizing the CRJs.  The CRJ payment made on the 1st of each month represents aprepayment based on an estimate of regional airline services to be provided byMesaba for the first 15 days of the month. The CRJ payment made on the 16th of the month consists of a prepayment basedon an estimate of regional airline services to be provided by Mesaba for the 16th through the end of themonth, as well as a true-up amount adjusting for actual services provided byMesaba in the prior month.

 

For flights utilizing the Saabs, Mesabarecognizes revenue for each completed available seat mile, or “ASM” (the numberof seats in an aircraft multiplied by the number of miles those seats areflown), and purchases fuel which is set at a fixed price of $0.835 per gallon,ground handling and other services from Northwest.  Mesaba paid Northwest $18.3 million, $21.9million and $19.7 million for ground handling and other services fiscal 2006,2005 and 2004, respectively.

 

For flights utilizing the Avros, Mesabarecognizes revenue for each block hour flown (the elapsed time between aircraftdeparting and arriving at a gate). Northwest provides fuel and airport and passenger related services atNorthwest’s expense for the Avros.

 

For flights utilizing the CRJs, Mesabarecognizes revenue through monthly expense reimbursement payments for actualexpenses incurred relating to aircraft rent, maintenance, landing fees and fuel(which is set at a fixed price of $0.70 per gallon for the CRJs); semi-monthlypayments for each block hour and cycle operated; a monthly fixed cost paymentbased on the size of the CRJ fleet (intended to cover Mesaba’s costs that arenot reimbursed through the monthly reimbursement payments, which consist mainlyof labor costs, ground handling costs, overhead and depreciation) and marginpayments based on the revenues described above calculated to achieve a targetoperating margin.  The target operatingmargin through April 2007 is set at a fixed amount, after which time the targetoperating margin will be based on the average operating margin of the publiclytraded United States domestic regional airlines operating primarily regionaljet aircraft, excluding Pinnacle Airlines Corp. (“Pinnacle”), and any regionalcarrier under bankruptcy protection, subject to a margin cap and floor.

 

The ASA contains termination provisions thatallow both Mesaba and Northwest to terminate the ASA in the event the otherparty breaches the agreement, subject to the other party’s right to cure thebreach within a prescribed time period. Additionally, Northwest may terminate the ASA in the event of certainlease and other performance defaults by Mesaba; failure by Mesaba to maintainrequired insurance coverage; failure by Mesaba to allow inspections pursuant tothe ASA; change in control events; revocation or failure by Mesaba to obtainDepartment of Transportation (“DOT”) certification; if Mesaba or its affiliatesoperate an aircraft type that causes Northwest to be in violation of itscollective bargaining agreement with its pilots; failure to elect a chiefexecutive officer/president of Holdings or Mesaba reasonably acceptable toNorthwest; if a specified percentage of the aircraft subject to the agreementare not operated for a specified period of time, other than as a result of theFederal Aviation Administration (the “FAA”) grounding all aircraft for allcarriers; if there is a strike, cessation or interruption of work 

 

 

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involving Mesaba pilots, flight attendants ormechanics providing service; or if Holdings breaches its agreement entered intowith Northwest concurrently with the ASA.

 

Under the ASA, all scheduled flights thatMesaba operates are designated as Northwest flights using Northwest’sdesignator code in all computer reservation systems with an asterisk and afootnote indicating that Mesaba is the carrier providing the service.  In addition, flight schedules of Mesaba andNorthwest are closely coordinated to facilitate interline connections, andMesaba’s passenger gate facilities at the Minneapolis/St. Paul InternationalAirport, Detroit Metropolitan Airport and Memphis International Airport areintegrated with Northwest’s facilities in the main terminal buildings.

 

Mesaba, through the ASA, receives ticketingand certain check-in, baggage, freight and aircraft handling services fromNorthwest at certain airports.  Inaddition, Mesaba receives its computerized reservations services fromNorthwest.  Northwest also performs allmarketing, scheduling, yield management and pricing services for Mesaba’sflights.

 

The ASA provides for incentive payments fromNorthwest to Mesaba based on achievement of certain operational goals on asemi-annual basis.  Such incentivestotaled $3.7 million, $3.1 million and $4.6 million in fiscal 2006, 2005 and2004, respectively.

 

Approximately $25.7 million, net of reserve,or 79.2% and $25.9 million, or 88.8%, of Mesaba’s March 31, 2006 and 2005accounts receivable balances were due from Northwest and were notcollateralized.

 

Upon execution of the ASA, and pursuant to aseparate agreement between Holdings and Northwest, Holdings issued to Northwestan amended and restated warrant (the “Warrant”) to replace the warrants held byNorthwest to reduce the number of shares of Holdings’ common stock issuable uponexercise from 4,151,922 shares exercisable at prices ranging from $7.25 to$21.25 per share to an aggregate of 4,112,500 shares exercisable at a price of$8.74 per share.  The Warrant expires tenyears from the date of the ASA.  TheWarrant will become exercisable for sixty percent of the shares upon thedelivery by Northwest of the 15th CRJ aircraft to Mesaba and anadditional 4% of the shares with each subsequent delivery of each of the nextten CRJ aircraft.

 

To date, Northwest has delivered only two CRJaircraft to Mesaba.  Northwest hasadvised Mesaba that it will remove one of the CRJs that Mesaba currentlyoperates and place the CRJ with Northwest’s newly formed subsidiary, CompassAirlines, Inc. (“Compass”).  As part ofits reorganization, Northwest has also requested bids from regional airlinesfor the operation of up to 126 CRJ aircraft, 124 of which are currentlyoperated by Pinnacle and two of which are operated by Mesaba.  Mesaba has submitted a proposal to conductall CRJ flying for Northwest.  If Mesabais not awarded some or all of the CRJ business, Northwest will remove the otherCRJ that Mesaba currently operates.  IfMesaba is awarded additional CRJs by Northwest, it is possible that the termsof the Warrant may be renegotiated to reflect any new arrangement between theparties.

 

Holdings also entered into a registrationrights agreement to cover the registration of the shares of stock currentlyheld by Northwest and the shares of stock that could be issued to Northwestupon exercise of the Warrant.  To date,the Company has not filed this registration statement, and it is unlikely thatone will be filed unless and until the exact nature of the relationship betweenMesaba and Northwest is determined via each company’s respective bankruptcy proceedings.

 

In connection with the ASA, Mesaba incurredall of the start-up costs necessary to bring the CRJ fleet into service.  For the fiscal year ended March 31, 2006,Mesaba incurred and expensed approximately $7.0 million in start-up costsrelated to adding the CRJ aircraft into its fleet, and Holdings incurred andexpensed approximately $0.3 million in related start-up costs.

 

 

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Finally, in connection with the ASA, andpursuant to its separate agreement with Northwest, Holdings made a capitalcontribution of approximately $31.7 million to Mesaba in September 2005, justprior to Northwest filing for bankruptcy.

 

*Big Sky*

Big Sky operates as a regional air carrierbased in Billings, Montana, providing scheduled passenger, freight, expresspackage and charter services.  As ofMarch 31, 2006, Big Sky provided scheduled air service to 22 communities inMontana, Colorado, Idaho, Oregon, Washington and Wyoming.  Big Sky operates daily scheduled flightsproviding interline and online connecting services and local marketservices.  Big Sky also has code-sharingagreements with Alaska Airlines, Horizon Air, America West Airlines, US Air andNorthwest, where its services are marketed jointly with those air carriers forconnecting flights.  Big Sky beganservice to Pocatello, Idaho and Walla Walla, Washington in the fourth quarterof fiscal 2006.

 

Big Sky participates in the Essential AirService (“EAS”) program with the DOT. The EAS program subsidizes air carriers to provide air service todesignated rural communities throughout the country that could not otherwiseeconomically justify that service based on their passenger traffic.  The DOT pays EAS subsidies for each departurein a covered market.  Big Sky was recentlyreselected as the EAS provider for seven Montana cities for a two-year periodbeginning March 1, 2006.

 

Big Sky purchased fuel from Northwest for$1.4 million, $1.7 million and $1.9 million in fiscal 2006, 2005 and 2004,respectively.

 

**Regulations**

 

Pursuant to Federal aviation laws, the DOTand the FAA have certain regulatory authority over the operations of all aircarriers.  The jurisdiction of the FAAextends primarily to the safety and operational provisions of the FederalAviation Act, while the responsibility of the DOT involves principally theregulation of certain economic aspects of airline operations.

 

*FAARegulation*

Mesaba and Big Sky each hold an air carriercertificate issued by the FAA permitting Mesaba and Big Sky to conduct flightoperations in compliance with Federal Aviation Regulations, which are the sameregulatory requirements applicable to major airlines.  The FAA regulations to which Mesaba and BigSky are subject are extensive and include, among other items, regulation ofaircraft maintenance and operations, equipment, ground facilities, dispatch,communications, training, weather observation, flight personnel and othermatters affecting air safety.  To ensurecompliance with its regulations, the FAA requires airlines to obtain operating,airworthiness and other certificates that are subject to suspension orrevocation for cause.  Mesaba and Big Skyhold all certificates necessary for their operations.

 

Under FAA regulations, Mesaba and Big Skyhave established, and the FAA has approved, maintenance programs for allaircraft they operate.  These programsprovide for the ongoing maintenance of Mesaba’s and Big Sky’s aircraft, rangingfrom frequent routine inspections to major overhauls.  Mesaba’s and Big Sky’s aircraft requirevarious levels of maintenance or “checks” and periodically undergo completeoverhauls.  Maintenance programs aremonitored closely by the FAA, with FAA representatives routinely present at theairline’s maintenance facilities.  TheFAA issues Airworthiness Directives (“ADs”), which mandate changes to an aircarrier’s maintenance program.  TheseADs, which include requirements for structural modifications to certainaircraft, are issued to ensure that the nation’s transport aircraft fleetremains airworthy.  Mesaba and Big Skyare currently, and expect to remain, in compliance with all applicablerequirements under all ADs and FAA approved maintenance programs.

 

 

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*DOTRegulation*

Mesaba and Big Sky each hold a Certificate ofPublic Convenience and Necessity issued by the DOT under federal aviationlaws.  As certificated carriers, Mesabaand Big Sky are required to file quarterly reports with the DOT, including areport of aircraft operating expenses and related statistics.

 

*TransportationSecurity Administration Regulation*

In response to the terrorist attacks ofSeptember 11, 2001, Congress enacted the Aviation and Transportation SecurityAct of 2001 (the “ATSA”).  The ATSAcreated the Transportation Security Administration (the “TSA”) to overseeaviation and airport security.  Amongother security measures, the ATSA enhanced background checks, provided forfederal air marshals aboard flights, improved flight deck security, enhancedairline crew security training, improved training of security screeningpersonnel and enhanced airport perimeter access.

 

*EmergencyWartime Supplemental Appropriations Act*

In April 2003, Congress enacted the EmergencyWartime Supplemental Appropriations Act (the “Wartime Act”), which included,among other items, a $2.3 billion grant to United States airlines for securityfees previously remitted to the TSA and $100 million for reimbursement ofaircraft cockpit door reinforcement costs. In connection with reimbursements under the Wartime Act, for the yearended March 31, 2004, Mesaba recognized $2.3 million as “other nonoperatingincome,” and Big Sky recognized $0.3 million as “other nonoperating income” and$0.2 million as a reduction of “administrative and other expense” in theaccompanying consolidated statements of operations.  Expenditure of these funds requirescompliance with the provisions of the Wartime Act.

 

*RailwayLabor Act*

Mesaba’s and Big Sky’s relations with itslabor unions are governed by the Railway Labor Act (the “RLA”).  Comprehensive provisions are set forth in theRLA establishing the right of airline employees to organize and bargaincollectively and imposing a duty upon air carriers and their employees to exertevery reasonable effort to make and maintain collective bargainingagreements.  The RLA contains detailedprocedures which must be exhausted before a lawful work stoppage may occur,including a formal declaration of an impasse by the National Mediation Board.

 

*Environmental Regulations*

Mesaba and Big Sky are subject to regulationunder various environmental laws and regulations, including the Clean Air Act,the Clean Water Act and Comprehensive Environmental Response, Compensation andLiability Act of 1980.  In addition, manystate and local governments have adopted environmental laws and regulations towhich Mesaba’s and Big Sky’s operations are subject.  Environmental laws and regulations areadministered by numerous federal and state agencies.  Management of Mesaba and Big Sky believe thatthey are in compliance with standards for aircraft exhaust emissions and fuelstorage facilities issued by the Environmental Protection Agency.

 

*OtherRegulations*

Under the Noise Control Act of 1972 and theAviation Safety and Noise Abatement Act of 1979, the FAA has authority to monitorand regulate aircraft engine noise. Management of Mesaba and Big Sky believe that their aircraft comply withor are exempt from such regulations.  Asa foreign carrier operating in Canada, Mesaba is subject to regulation byCanada’s Transport Canada department and has been issued a Foreign Air CarrierOperating Certificate and Canadian Transportation Agency economic license.  Because Northwest maintains certain contractswith the Department of Defense, Mesaba is subject to that department’s periodicinspections.

 

 

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**Insurance**

 

The Company carries the types of insurancecustomary in the airline industry, including coverage for public liability,passenger liability, property damage, aircraft loss or damage, baggage andcargo liability, war risk, directors’ and officers’ and workers’compensation.  Mesaba, through the ASA,purchases aviation liability, war risk and hull coverage through a combinedplacement with Northwest.  The ASArequires that Mesaba maintain specified levels of insurance coverages and alsoobligates Northwest to use commercially reasonable efforts to allow Mesaba tocontinue to participate in Northwest’s insurance plan.

 

Both Mesaba and Big Sky were given the optionunder the ATSA to purchase certain third-party war risk liability insurancefrom the United States government on an interim basis at rates that are morefavorable than those available from the private market.  Mesaba and Big Sky have purchased thisinsurance from the FAA as provided under the ATSA.

 

**Competition**

 

The airline industry is highly competitive asa result of the Airline Deregulation Act of 1978 (the “Deregulation Act”),which generally increased competition by eliminating restrictions on fares androute selection.  The Deregulation Actalso contributed to the withdrawal of national and major carriers fromshort-haul markets by allowing them to more easily obtain additional long-haulroutes, which can be more efficiently and profitably served by larger jetaircraft.  Elimination of barriers toentry into new markets, however, also created greater potential for competingservice by other carriers operating small, fuel-efficient aircraft onshort-haul routes serving small and medium-sized cities.  Mesaba and Big Sky compete with otherregional airlines on most routes they serve. Mesaba and Big Sky also face competition from regional carriers offeringservice to alternative hubs for connecting flights.  Other carriers, including major carriers, canat any time institute competing service on routes served by Mesaba or Big Sky.

 

The ASA does not prohibit Northwest fromcontracting with other regional airlines to provide the same services thatMesaba currently provides.  Northwestcurrently has an airline services agreement with Pinnacle, and Pinnacle servesmany of the same cities as Mesaba. Northwest could choose to expand its agreement with Pinnacle incompetition with Mesaba.  Northwest couldalso choose to establish relationships with other regional airlines.  Finally, Northwest has formed a newsubsidiary, Compass, and Northwest intends to use this subsidiary to operateregional flights.

 

Competitive factors in the airline industrygenerally include fares, frequency and dependability of service, convenience offlight schedules, type of aircraft flown, airports served, relationships withtravel agents, and efficiency and reliability of reservations systems andticketing services.  The compatibility offlight schedules with those of other airlines and the ability to offer throughfares and convenient inter-airline flight connections are also importantcompetitive factors.

 

**Fuel**

 

The Company believes that the followingarrangements assure an adequate supply of fuel for current and futureoperations for both Mesaba and Big Sky, provided that Northwest does notexperience a supply shortage.

 

*Mesaba*

Mesaba has arrangements with Northwest forits fuel requirements.  Certainprovisions of the ASA protect Mesaba from fluctuations in aviation fuel pricesfor Saab and CRJ flights.  The ASA alsorequires Northwest to provide fuel for the Avros, at Northwest’s expense, toMesaba.

 

 

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*Big Sky*

Big Sky purchases its fuel under arrangementswith several fuel suppliers.  None ofthese arrangements provides protection from fluctuations in fuel prices andsupply.

 

**Fares**

 

*Mesaba*

Mesaba derives its passenger revenue byselling its capacity to Northwest at predetermined rates.  Under the ASA, Mesaba is primarily paid byNorthwest per available seat mile or per completed block hour, depending on thetype of aircraft operated.

 

*Big Sky*

Big Sky generates its passenger revenues frompassenger ticket sales through participation in Airline Reporting Corp., aclearinghouse for travel agencies, its own reservations center in Billings, aticket by mail program and on-line e-ticketing. Big Sky has ticketing and baggage agreements with all major airlinesthat serve its region, which allow its services to be sold by those airlines.  Big Sky establishes its passenger fares on amarket-by-market basis utilizing a combination of factors, including the costof providing the service based upon projected passenger levels, the competitiveprice of alternative means of transportation (including both air and surface)and the distance between markets.

 

**AircraftMaintenance**

 

The maintenance performed on Mesaba’s and BigSky’s aircraft can be divided into two general categories:  routine line maintenance and majoroverhauls.  Line maintenance consists ofroutine daily and weekly scheduled maintenance checks on aircraft, includingpre-flight, daily, weekly and overnight checks and any diagnostic and routinerepairs.  Mesaba and Big Sky employ theirown aircraft, avionics and engine maintenance staffs that perform substantiallyall routine line maintenance to the aircraft and engines.  Mesaba contracts out most of its majoroverhauls on airframes, engines and other rotable parts on the aircraft at FAAauthorized facilities.  Major overhaulson Big Sky’s fleets, including airframes, engines and other rotable parts, areperformed internally or at FAA authorized facilities.

 

**Airportand Terminal Services**

 

Mesaba’s ticket counter and baggage-handlingspace is leased from local airport authorities or other airlines at all of theairports served.  In certain of thecities it serves, Mesaba receives support services under agreements withNorthwest.  In accordance with the ASA,for flights utilizing Saabs, Mesaba pays local airport authorities for the useof the landing fields at rates that are based on the number of flights per day,fixed fees or on the number of aircraft landings and aircraft weight.  Northwest pays for Mesaba’s landing fees forflights utilizing Avros.

 

Mesaba receives other revenue from Northwest,Pinnacle and other airlines for ground handling services performed at theMinneapolis/St. Paul, Detroit and other spoke airports.

 

Big Sky leases airport counter, baggage andramp space for ground services and customer services at all of the cities itcurrently serves.  Big Sky contracts forground handling services from other airlines as needed.

 

 

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**Employees**

 

As of March 31, 2006, Holdings had fiveemployees, and its subsidiaries employed 3,779 employees with approximately 41%of those employees represented by labor unions. Mesaba had 3,535 (1,128 part-time) employees, and Big Sky had 244 (58part-time) employees.  Neither Mesaba norBig Sky had any official work stoppages during fiscal 2006.  The Company’s labor agreements are asfollows:

 

*Mesaba*

 
| **Employee Group**                      | ** ** | **Approximate   Number of   Employees** | ** ** | **Union**                                                   | ** ** | **Amendable Date** | ** ** |
|-----------------------------------------|------------|-----------------------------------------|------------|-------------------------------------------------------------|------------|--------------------|------------|
| Pilots                                  |       | 750                                     |       | Air Line Pilots Association ("ALPA")              |       | January  2009      |       |
| Mechanics                               |       | 227                                     |       | Aircraft Mechanics Fraternal Association ("AMFA") |       | August  2003       |       |
| Dispatchers                             |       | 28                                      |       | TWU                                                         |       | May  2005          |       |
| Flight Attendants                       |       | 410                                     |       | Association of Flight Attendants                            |       | April  2006        |       |
| Customer service agents                 |       | 1,684                                   |       | None                                                        |       |               |       |
| Management /  Administrative / Clerical |       | 436                                     |       | None                                                        |       |               |       |
|                                    |       | 3,535                                   |       |                                                        |       |               |       |

 

As discussed above in “Mesaba Bankruptcy,”Mesaba sought approval from the Bankruptcy Court to reject all of its CBAs andimpose new contract terms on its labor unions. On January 31, 2006, the Bankruptcy Court approved Mesaba’s tentativeagreement reached with the TWU.  TheBankruptcy Court heard testimony from Mesaba and the remaining three unions forMesaba’s pilots, mechanics and flight attendants in February and March2006.  On May 18, 2006, the BankruptcyCourt denied Mesaba’s motion to reject. Although the Bankruptcy Court agreed with Mesaba’s core businessassumptions, the court ruled that Mesaba failed to satisfy certain technicalelements required to authorize rejection of the labor contracts.  The Bankruptcy Court stated that if Mesabachooses to remedy the defects in its original motion, the court would hear arenewed motion in a prompt manner.  OnJune 12, 2006, Mesaba filed a renewed motion for authority to reject its CBAs,and the Bankruptcy Court began hearing the motion on June 26, 2006.  Mesaba is continuing to negotiate with itsunions and remains committed to reaching consensual agreements.  However, there can be no assurance thatMesaba will be able to do so.

 

 

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*Big Sky*

 
| **Employee Group**                      | ** ** | **Approximate   Number of   Employees** | ** ** | **Union**                                                     | ** ** | **Amendable Date** | ** ** |
|-----------------------------------------|------------|-----------------------------------------|------------|---------------------------------------------------------------|------------|--------------------|------------|
| Pilots                                  |       | 68                                      |       | United Transportation Union                                   |       | December  2009     |       |
| Mechanics                               |       | 27                                      |       | International Association of Machinists and Aerospace Workers |       | August  2010       |       |
| Dispatchers                             |       | 9                                       |       | United Transportation Union                                   |       | December  2009     |       |
| Customer service agents                 |       | 105                                     |       | None                                                          |       |               |       |
| Management /  Administrative / Clerical |       | 35                                      |       | None                                                          |       |               |       |
|                                    |       | 244                                     |       |                                                          |       |               |       |

 

**Cyclicalityand Seasonality**

 

The airline industry generally is subject tocyclical moves in the economy.  Becauseboth personal discretionary travel and business travel may be expected todecline during periods of economic weakness, the airline industry tends toexperience poorer financial results during such periods.

 

Mesaba’s cyclicality is tied to the businessand operating decisions of Northwest. Operations of the major airlines continue to be impacted by the rapidgrowth of low cost airlines, the increasing number of businesses utilizingteleconferencing or web-based meetings and the advent of internet travel websites, which enable consumers to find travel alternatives.  Mesaba has historically shown greaterrevenues and earnings in the first and second fiscal quarters.  Northwest has historically seen increasedleisure travel during these periods on domestic and international routes, whichcontributes to an increased number of flights for Mesaba.

 

Seasonal factors, primarily weatherconditions and passenger demand, generally affect Big Sky’s monthly passengerboardings.  Big Sky has historicallyshown a higher level of passenger boardings in the July through December periodas compared with the January through June period for many of the citiesserved.  As a result of such factors, BigSky’s revenues and earnings have shown a corresponding increase during the Julythrough December period.

 

**RecentDevelopments**

 

As discussed more fully in “Item 8. FinancialStatements and Supplemental Data, Note 19 — Subsequent Events,” Holdingsunconditionally guaranteed Mesaba’s obligations related to Mesaba’s facility atthe Cincinnati/Northern Kentucky International Airport.  In accordance with this guaranty, Holdingshas been making the required bond and lease payments on the facility since thePetition Date.  On February 15, 2006,Holdings received notice declaring Holdings’ liability for all sums to beimmediately due and payable.  On April18, 2006, Holdings entered into an agreement with UMB Bank, N.A. (“UMB”), thetrustee for the bondholders, under which UMB agreed to forbear acceleration ofHoldings’ guarantee obligations in exchange for Holdings delivering a letter ofcredit in the amount of $13.1 million to secure the payment of the obligationsguaranteed by Holdings to UMB.

 

 

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**AvailableInformation**

 

The Company maintains a website atwww.mairholdings.com.  On its website,free of charge, the Company makes available its Annual Report on Form 10-K andlinks to the SEC website for other public filings.  The company’s Code of Ethics for its ChiefExecutive Officer and financial officers is also available on its website.  All information is also available in printupon written request to the Company’s General Counsel at 150 South FifthStreet, Suite 1360, Minneapolis, Minnesota 55402.  The Company is not including the informationcontained on or available through its website as a part of, or incorporatingsuch information by reference into, this Annual Report on Form 10-K.

 

## ***Item1A.  RISK FACTORS***

 

The Company’s operations and financialresults are subject to various risks and uncertainties, some of which aredescribed below.  The Company could alsobe adversely affected by additional risks and uncertainties not presently knownor believed to be material.

 

**RisksRelated to Mesaba’s Bankruptcy**

 

*Mesaba’soperation during bankruptcy and its emergence from bankruptcy will requireinteraction with its Creditors’ Committee.*

 

The United States Trustee for the District ofMinnesota has appointed a Creditors’ Committee in Mesaba’s bankruptcycase.  The Creditors’ Committee and itslegal representatives have a right to be heard on all matters that come beforethe Bankruptcy Court concerning Mesaba’s reorganization.  There can be no assurance that the Creditors’Committee will support Mesaba’s positions or its plan of reorganization, andany disagreements between the Creditors’ Committee and Mesaba could protractthe Chapter 11 process, hinder Mesaba’s ability to operate during the Chapter11 process and delay Mesaba’s emergence from Chapter 11.

 

*IfMesaba is unable to obtain debtor-in-possession financing, it may be unable toemerge from bankruptcy.*

 

When Mesaba filed for Chapter 11 bankruptcyprotection, Holdings provided a commitment to provide a certain level ofdebtor-in-possession financing.  Holdings’commitment to provide such financing expired on March 24, 2006.  Mesaba is actively seeking financing fromother sources, but there can be no assurance that Mesaba will be able to obtainsuch financing.  If Mesaba is unable toobtain adequate debtor-in-possession financing by the end of the second quarterof fiscal 2007, Mesaba could run out of cash and be forced to convert to aChapter 7 bankruptcy liquidation.

 

*IfMesaba is unable to confirm a reorganization plan, it may be unable to emergefrom bankruptcy.*

 

In order for Mesaba to emerge frombankruptcy, the Bankruptcy Court must approve a reorganization plan forMesaba.  The reorganization plan will besubject to a vote by certain classes of creditors, including Mesaba’s securedcreditors and unsecured creditors.  TheBankruptcy Court will generally not approve a reorganization plan unless allimpaired classes of creditors vote to accept the plan; however, Mesaba mayelect to invoke certain provisions of the Bankruptcy Code in order to obtainconfirmation of the plan over the vote of a dissenting class of creditors.  In addition to the voting requirements forconfirmation, Mesaba will have to satisfy other provisions of the BankruptcyCode in order to confirm its reorganization plan, including showing that theplan is feasible.  If Mesaba is unable tomeet these confirmation requirements, it may be unable to emerge frombankruptcy.

 

 

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*IfHoldings is unable to find an alternate sublessee for Mesaba’sCincinnati/Northern Kentucky Airport facility, Holdings may be required toaccrue an additional $8.2 million of expense related to the bonds associatedwith the initial financing of the facility.*

 

Mesaba currently leases a facility at theCincinnati/Northern Kentucky International Airport, but vacated the facilityand ceased making the required lease payments on it in November 2005.  Holdings unconditionally guaranteed full andprompt payment of the ground lease and the bonds associated with the initialfinancing of the facility.  In accordancewith this guaranty, Holdings has made the required bond and ground leasepayments due since November 2005.  InApril 2006, in exchange for the bondholders forbearing acceleration of thebonds, Holdings delivered a letter of credit to the bondholders to assurepayment of the bonds.  As of December 31,2005, Holdings recorded a $4.8 million liability with respect to the lease andguaranty, which assumed that the facility would remain vacant for the next twoyears, during which time Holdings would continue to make the bond and leasepayments, and that thereafter Holdings would be able to sublease the facilityat a 20% discount.  If Holdings is unableto find an alternate sublessee for the facility, Holdings may be required torecord an additional liability of up to $8.2 million.

 

*Anycourt-approved reorganization by Mesaba could result in Holdings losing all ora portion of its equity in Mesaba*.

 

In general, the absolute priority rule in theBankruptcy Code requires that all of the debtor’s creditors must be paid infull; otherwise the equity holders in the debtor are not entitled to retaintheir equity interests, unless certain exceptions to the absolute priority ruleare met.  It will likely be some timebefore Mesaba proposes a reorganization plan. However, the outcome of any vote on Mesaba’s reorganization plan, aswell as the terms and conditions of the plan itself, will determine whetherHoldings risks losing some or all of its ownership in Mesaba due to theapplication of the absolute priority rule.

 

*Mesabamay need exit financing to emerge from bankruptcy, and there is no assuranceMesaba can obtain exit financing.*

 

The terms of any debtor-in-possessionfinancing provided to Mesaba will likely require such financing to be repaidupon Mesaba’s exit from bankruptcy. Accordingly, Mesaba will need to provide for the repayment of anydebtor-in-possession financing through a source of exit financing or throughsome other means.  There is no assurancethat such exit financing will be available to Mesaba upon its exit frombankruptcy or that Mesaba will have the means to repay any debtor-in-possessionfinancing without exit financing.

 

*Part ofMesaba’s bankruptcy strategy is to achieve labor cost savings, the threat ofwhich could cause slowdowns or other labor unrest by Mesaba’s labor unions.*

 

Since November 2005, Mesaba has been engagedin negotiations with all of its unions to address the need for contracts thatare consistent with changing company and industry conditions.  To that end, Mesaba filed a motion with theBankruptcy Court requesting authorization to reject all of its CBAs.  On January 31, 2006, the Bankruptcy Courtapproved the tentative agreement reached between Mesaba and the TWU.  The Bankruptcy Court heard testimony fromMesaba and the remaining three unions for Mesaba’s pilots, mechanics and flightattendants in February and March 2006. On May 18, 2006, the Bankruptcy Court denied Mesaba’s motion toreject.  Although the Bankruptcy Courtagreed with Mesaba’s core business assumptions, the court ruled that Mesabafailed to satisfy certain technical elements required to authorize rejection ofthe labor contracts.  The BankruptcyCourt stated that if Mesaba chooses to remedy the defects in its originalmotion, the court would hear a renewed motion in a prompt manner.  On June 12, 

 

 

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2006, Mesaba filed a renewed motion forauthority to reject its CBAs, and the Bankruptcy Court began hearing the motionon June 26, 2006.

 

While Mesaba remains committed to reachingnegotiated agreements with these unions, there is no guarantee that Mesaba willbe able to do so or that it will be able to do so in accordance with Mesaba’splanned timeframe for implementing labor cost savings.  Furthermore, it is possible that members ofthese unions will participate in work slowdowns or other labor unrest toprotest Mesaba’s requested new contract terms. In addition, Mesaba has experienced an increase in non-union employeeturnover.  If the high attrition ratecontinues, Mesaba could experience operating disruptions.  Any labor unrest and any additional delay inachieving labor cost savings will result in a material adverse effect on Mesaba’sfinancial condition and results of operations.

 

*If, inthe process of performing its duties, Mesaba’s Creditors’ Committee believesany claims exist regarding Mesaba’s relationship with Holdings, the Creditors’Committee could assert such claims against Holdings.*

 

Certain provisions of the Bankruptcy Codeallow a debtor-in-possession to recover transfers of cash or other propertythat were made prior to the debtor’s bankruptcy filing.  As a result, one of the traditional duties ofan official committee of unsecured creditors appointed in a bankruptcy case isto examine transactions between a debtor-in-possession and its affiliates.  In Mesaba’s bankruptcy case, the Creditors’Committee has requested the right to review various documents concerningtransactions between Holdings and Mesaba, including the payment of dividendsfrom Mesaba to Holdings, and to take depositions in order to understand thesetransactions.  Holdings believes alldividends paid by Mesaba were appropriate and in compliance with therequirements of the Minnesota Business Corporation Act.  However, in order to address any questionsabout the relationship between Holdings and Mesaba, Holdings has entered intoan agreed protective order with the Creditors’ Committee to voluntarily providedocuments explaining the relationship between Holdings and Mesaba and toprovide witness testimony concerning the documents provided.  The Creditors’ Committee has not completedits review of the transactions between Holdings and Mesaba and, consequently,the Creditors’ Committee has not yet advised Holdings of any specific claimsarising from its review.

 

*Mesaba has experienced a highattrition rate in its accounting, finance and information technologydepartments, and if Mesaba is unable to replace individuals in these areas,Mesaba’s internal control over financial reporting may be adversely affected.*

 

Since Mesaba filed for bankruptcy protectionon October 13, 2005, Mesaba has experienced resignations of key personnel inthe accounting and SEC reporting functions as well as the informationtechnology area, which provides technical support to the finance department.  Additionally, Mesaba has begun to implementcompany-wide staff reductions and a reorganization of its operations.  Mesaba has added contract workers andconsultants as temporary replacements of the key personnel who have resigned,and Mesaba expects that it will be able to continue to engage consultants andother temporary replacements for these positions in the near future.  However, if Mesaba is not able tosuccessfully attract qualified permanent employees to fill these key positions,Mesaba’s internal control over financial reporting could be adversely affected.

 

 

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**RisksRelated to Mesaba’s Relationship with Northwest**

 

*Mesabais dependent on its relationship with Northwest as its major customer, and theloss of this relationship would substantially harm the Company’s financialresults.*

 

During fiscal 2006, Northwest accounted for94.5% of Mesaba’s operating revenues. Additionally, Mesaba consistently carries a receivable due fromNorthwest between $12 million to $16 million that is not collateralized.  Due to Northwest’s missed payments prior toand following its bankruptcy filing, Mesaba recorded a reserve of thereceivable due from Northwest, net of certain offsetting liabilities, throughSeptember 13, 2005, the date of Northwest’s bankruptcy filing.  Mesaba’s future success will depend uponNorthwest’s ability to successfully restructure through bankruptcy.  Further, Northwest’s bankruptcy haseffectively placed Mesaba’s contracts with Northwest at risk, as Northwest hasthe option to assume or reject or renegotiate each of such contracts inconnection with its bankruptcy proceedings.

 

Mesaba is currently continuing to operateflights for Northwest, but the exact nature of Mesaba’s future relationshipwith Northwest may not be known until such time as Northwest adopts itsbankruptcy reorganization plan.  As ofJune 8, 2006, Northwest had removed 13 Saabs and 19 Avros from Mesaba’sfleet.  In January 2006, Northwestadvised Mesaba that the remaining Avros operated by Mesaba will be removed bythe end of December 2006.  Northwest alsoadvised Mesaba that it will remove one of the CRJs that Mesaba currentlyoperates and place the CRJ with Northwest’s newly formed subsidiary,Compass.  Finally, as part of itsreorganization, Northwest has requested bids from regional airlines for theoperation of up to 126 CRJs, 124 of which are currently operated by Pinnacle,and two of which are currently operated by Mesaba.  If Mesaba is not awarded some or all of theCRJ business, Northwest will remove the remaining CRJ from Mesaba’s fleet.  If Northwest rejects the ASA or negotiates anew ASA (and such renegotiation does not include a waiver by Mesaba of itsclaims against Northwest), the prepetition amounts owed to Mesaba by Northwestwould remain an unsecured claim, and Mesaba would likely receive only a smallpercentage of the amounts owed to it, and even then would only receive suchamounts after a plan of reorganization is approved by Northwest’s bankruptcycourt.

 

*Northwesthas not guaranteed that it will grow Mesaba’s regional fleet, and Northwestcould opt to operate new regional aircraft with its own new subsidiary orutilize other regional airlines.*

 

The ASA does not prohibit Northwest fromcontracting with other regional airlines to provide the same services thatMesaba currently provides.  Northwestcurrently has an airline services agreement with Pinnacle, and Pinnacle servesmany of the same cities as Mesaba.  Northwesthas issued a request for proposal for the operation of up to 126 CRJs (thetotal number of CRJs currently operated by Mesaba and Pinnacle combined), andNorthwest has also formed a new subsidiary, Compass, that could ultimatelyoperate regional aircraft.  Accordingly,Northwest could choose to expand its agreement with Pinnacle in competitionwith Mesaba or to contract with other regional airlines or to replace one orboth of its current regional airline partners with Compass.

 

**RisksRelated to the Company’s Business and Operation**

 

*Mesaba’sand Big Sky’s success is dependent on their ability to obtain all necessaryaircraft, engines, parts and related maintenance and support from variousaircraft manufacturers and vendors.*

 

Mesaba and Big Sky are dependent on variousaircraft manufacturers and other vendors to provide sufficient parts andrelated maintenance and support services on a timely basis.  Additionally, Mesaba and Big Sky rely onvarious engine manufacturers for parts, repair and overhaul services and othertypes of support services.  Mesaba’sbankruptcy and nonpayment for prepetition goods and services has adverselyaffected its relationship with certain vendors. The failure of aircraft or engine manufacturers and other 

 

 

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vendors to provide parts or related serviceson a timely, cost-effective basis could materially and adversely affect Mesaba’sor Big Sky’s business, financial condition and results of operations.

 

*BecauseMesaba is unable to pass along increased operating costs, Mesaba’s earningswill be negatively affected as its fleet continues to age.*

 

As Mesaba’s fleet of aircraft age, the costof maintaining the aircraft will likely increase.  Because many aircraft components are requiredto be replaced after a specified time, numbers of flight hours or take-off andlanding cycles, and because new aviation technology may require certain partsto be retrofitted, the cost to maintain aging aircraft will generally exceedthe cost to maintain newer aircraft.  Anymaterial increase in such costs will have a material adverse effect on Mesaba’sbusiness, financial condition and results of operations.

 

*IfMesaba loses certain of its ground handling business, Mesaba’s results ofoperations could be materially affected.*

 

Mesaba performs various ground handlingservices for Northwest, Pinnacle and other airlines at Minneapolis, Detroit andcertain other airport locations.  Theground handling business is highly competitive, and airlines are constantlyreviewing their cost structures to locate the most cost-effective ground handlingproviders.  Mesaba receives the majorityof its ground handling revenue from Northwest and Pinnacle, and Mesaba does nothave any long-term agreements with either airline.  If Northwest or Pinnacle terminates Mesaba’sground handling services, Mesaba’s financial results would be materiallyaffected, both through a loss of revenue and increased transition expenses.

 

*Mesabaand Big Sky could incur significant costs if they experience difficultyfinding, training and retaining employees.*

 

Mesaba’s and Big Sky’s businesses arelabor-intensive and require large numbers of pilots, flight attendants,maintenance technicians and other personnel. The airline industry has from time to time experienced a shortage ofqualified personnel, specifically pilots and maintenance technicians.  In addition, as is common with most airlinecompetitors, Mesaba and Big Sky have faced turnover of their employees.  For example, Mesaba’s and Big Sky’s pilotsand maintenance technicians, as well as Mesaba’s flight attendants, occasionallyleave to work for larger airlines which generally offer higher salaries andmore extensive benefit programs than regional airlines are financially able tooffer.  In the event of a significantincrease in the turnover of employees in the above-mentioned positions, Mesabaand Big Sky would incur significantly higher training costs than wouldotherwise be necessary.  Mesaba and BigSky cannot provide assurance that they will be able to recruit, train andretain the qualified employees they require to carry out their business plans.

 

*Mesabaand Big Sky could be adversely affected by the highly competitive nature of theairline industry.*

 

The airline industry is highly competitive,and Northwest competes not only with other regional carriers, but also withlow-cost airlines and major airlines on many of its routes, including theroutes that Mesaba flies.  Some of thesecompetitors are significantly larger and possess greater resources thanNorthwest.  Moreover, any new entry inthe markets Mesaba serves could lessen the economic benefits Northwest derivesfrom servicing these markets.  Finally,Big Sky also competes with low-cost and regional carriers on its routes, and itfaces the same competitive challenges described above.

 

 

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*Holdings’ ability to diversify within the airline industrymay be limited by the terms of its side letter agreement with Mesaba’s pilots’union.*

 

In January 2004, Holdings entered into aletter agreement with ALPA, Mesaba’s pilots’ union, that may limit the types ofaircraft Big Sky may fly and may place additional requirements on Holdings ifit forms or acquires any other airline subsidiary.  These possiblelimitations were included in Mesaba’s negotiations with its pilots in Mesaba’sbankruptcy proceedings, and the Bankruptcy Court ruled that Mesaba cannotreject the letter agreement.  In light of this ruling, Holdings iscurrently assessing its alternatives with respect to the letter agreement.

 

*Mesaba’sand Big Sky’s compliance with various regulations governing the airlineindustry can be costly, and Mesaba and Big Sky could be harmed if they fail tocomply with such regulations.*

 

Airlines are subject to extensive regulatoryand legal requirements that involve significant compliance costs that canresult in increased costs for passengers and the airline.  The FAA, DOT and Transportation SecurityAdministration periodically propose additional laws, regulations, taxes andairport rates and charges.  Such measurescould have the effect of raising ticket prices, reducing revenue, increasingcosts or reducing demand for air travel. Mesaba and Big Sky expect to continue incurring expenses to comply withexisting and future regulations. Moreover, if either Mesaba or Big Sky fails to comply with applicableregulations, they may be subject to sanctions, including the following:

 

•                  warningletters;

•                  fines;

•                  injunctions;

•                  orders relatingto grounding of aircraft, inspection of aircraft, installation of newsafety-related items and removal and replacement of certain aircraft parts; or

•                  criminalprosecutions.

 

*Futureterrorists attacks, other world events, general economic conditions and otherfactors beyond the Company’s control could substantially harm the Company.*

 

The terrorist attacks of September 11, 2001and the prolonged unrest in the Middle East materially affected and continue toaffect the airline industry.  Concernsabout further terrorist attacks have had a negative impact on air travel demand.  In addition, security procedures introducedat airports since the attacks have increased the inconvenience of air travel,both in reality and in customer perception, leading to further reduction indemand.  Finally, the continued rise injet fuel prices has had an adverse economic effect on all airlines, includingNorthwest and Big Sky.  Additionalterrorist attacks, the fear of such attacks, continued conflict in Iraq,Afghanistan or other countries or continued increases in fuel prices couldfurther affect the airline industry and could cause general instability infinancial markets.

 

Because a substantial portion of air travel,including business travel, is discretionary, the industry tends to experienceadverse financial results during general economic downturns.  Soft economic conditions continue to putpressure on the profitability of the industry. Any general decline in passenger traffic may harm the Company’sbusiness.

 

Mesaba’s and Big Sky’s operations are alsosubject to delays caused by factors beyond their control, including air trafficcongestion at airports, adverse weather conditions and increased securitymeasures.  Such delays frustratepassengers, reduce aircraft utilization and increase costs, all of which mayaffect profitability and harm the Company’s financial condition and results ofoperations.

 

 

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*Mesabaand Big Sky are increasingly dependent upon technology in their operations, andany failure of such technology could adversely affect them.*

 

Mesaba and Big Sky have made substantialinvestments in technology to manage their operations.  In particular, the systems operations controlcenters, which oversee daily flight operations, are dependent on a number oftechnology systems to operate effectively. These technology systems may be vulnerable to various sources ofinterruption due to events beyond Mesaba’s or Big Sky’s control, includingnatural disasters, terrorist attacks, computer viruses and hackers.  In addition, large-scale interruption intechnology on which Mesaba and Big Sky depend, such as power,telecommunications or the Internet, could substantially disrupt theiroperations.

 

*Anyairline accident in which Mesaba or Big Sky is involved could subject Mesaba orBig Sky to substantial liability and seriously harm the Company’s financialcondition and results of operations.*

 

An accident involving Mesaba or Big Skyaircraft could result in injuries and loss of life and, therefore, result insignificant claims from injured persons and surviving relatives.  An accident could also result in substantialproperty damage, loss of aircraft from service and adverse publicity for theaffected airline.  The DOT requiresairlines to carry liability insurance. Although Mesaba and Big Sky believe their liability insurance is in amountsand of the type generally consistent with industry practice, substantial claimsresulting from an accident in excess of insurance coverage would harm theCompany’s business and financial results. Any resulting claims would also be costly to defend and could harmMesaba’s or Big Sky’s reputation. Moreover, any aircraft accident, even if fully insured or not directlyinvolving Mesaba or Big Sky, could cause a public perception that flying isless safe or reliable than other transportation alternatives, which could harmthe Company’s financial condition and results of operations.

 

**RisksRelated to the Company’s Stock**

 

*Together,certain of the Company’s shareholders own or have the right to acquire asignificant portion of the Company’s stock and could ultimately controldecisions regarding the Company.*

 

Northwest owns 27.5% of the Company’s commonstock.  Pursuant to its Warrant,Northwest also has the right to purchase an aggregate of 4,112,500 shares ofthe Company’s common stock, subject to certain vesting restrictions related tothe future delivery by Northwest of CRJ aircraft.  It is possible that if Mesaba is awardedadditional CRJ aircraft by Northwest, Mesaba and Northwest may negotiate a newairline services agreement, and the Company and Northwest may then alsorenegotiate the terms of any warrant that may be issued.  Additionally, several other shareholders alsoown significant blocks of the Company’s common stock.  Because the parties described above currentlyown a large portion of the Company’s stock, they may be able to determine orsignificantly influence the outcome of corporate actions requiring shareholderapproval, including decisions as to the Company’s direction and policies;future issuances of securities, incurrence of debt, amendments to the Company’sarticles of incorporation and bylaws, payment of dividends on the Company’scommon stock; and acquisitions, sales of the Company’s assets, mergers orsimilar transactions, including transactions involving a change ofcontrol.  As a result, some investors maybe unwilling to purchase the Company’s common stock.  In addition, if the demand for the Company’scommon stock is reduced because of these shareholders’ control of the Company,the price of the Company’s common stock could be materially depressed.

 

*Futuresales of the Company’s common stock by its shareholders could depress the priceof the Company’s stock.*

 

Sales of a large number of shares of theCompany’s common stock or the availability of a large number of shares for salecould adversely affect the market price of the Company’s common stock.  As of March 31, 

 

 

19

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2006, the Company had 20,591,840 shares ofcommon stock outstanding.  Several of theCompany’s shareholders own substantial blocks of the Company’s commonstock.  Additionally, along with theshares of stock it currently owns, Northwest could own an additional largeblock of the Company’s common stock upon exercise of its Warrant.  In connection with the ASA, the Company enteredinto a registration rights agreement to register the shares of stock owned byNorthwest (including those shares underlying the Warrant).  Prior to entering the ASA, Northwest hadpledged certain of these shares to Boeing Capital Corporation (“Boeing”), andBoeing is also a party to the registration rights agreement.  The registration statement has not beenfiled, and will likely not be filed until a final resolution is reached withrespect to the ASA, unless Boeing obtains relief from the automatic stay and isallowed to foreclose on Northwest’s stock pledge and subsequently demandregistration.  Nevertheless, followingany registration, future sales of those shares, or future sales of other largeblocks of the Company’s common stock that are already registered, couldsubstantially depress the Company’s stock price.

 

*Anyfuture exercise of the Warrant held by Northwest could substantially dilute theCompany’s common stock.*

 

As of March 31, 2006, Northwest held aWarrant exercisable for an aggregate of 4,112,500 shares of the Company’scommon stock at an exercise price of $8.74 per share.  To date, the Warrant has not vested, and itwill not begin to vest until Northwest delivers a total of 15 CRJs toMesaba.  In such event, the Company andNorthwest may also renegotiate the terms of the Warrant.  If and when the Warrant does vest, holders ofthe Company’s common stock could experience substantial ownership dilution ifNorthwest elects to exercise the Warrant.

 

*TheCompany’s stock price may continue to be volatile.*

 

In the past two fiscal years, the marketprice of the Company’s common stock has ranged from a low of $4.50 per share toa high of $10.23 per share.  Because theCompany’s stock is thinly traded, its market price is sensitive and maycontinue to experience substantial fluctuations due to a variety of factors,including the following:

 

•                  failure of theCompany’s operating results to meet analysts’ or investors’ expectations in anyquarter;

•                  securitiesanalysts’ estimates;

•                  materialannouncements by the Company, Northwest or the Company’s, Mesaba’s or Big Sky’scompetitors;

•                  public sales ofa substantial number of shares of the Company’s common stock;

•                  increased shortsales due to the uncertainty surrounding Mesaba’s bankruptcy, as well as anypurchase to cover short positions;

•                  regulatoryactions; or

•                  general marketconditions.

 

*Anti-takeoverprovisions of the Company’s articles of incorporation and bylaws and ofMinnesota law could discourage, delay or prevent a change in control.*

 

The Company’s articles of incorporation andbylaws, along with Minnesota law, could discourage, delay or prevent personsfrom acquiring or attempting to acquire the Company.  The Company’s articles of incorporationauthorize the board of directors, without action by the Company’s shareholders,to designate and issue preferred stock in one or more series, with such rights,preferences and privileges as the board of directors shall determine.  The Company’s articles of incorporation andbylaws also mandate a classified board of directors, which makes changingcontrol of the board more difficult.  The

 

 

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Company’s bylaws grant the board of directorsthe authority to adopt, amend or repeal all or any of such bylaws, subject tothe power of the shareholders to change or repeal such bylaws.  The Company’s bylaws also limit who may callmeetings of the Company’s shareholders.

 

As a public corporation, the Company isprohibited by the Minnesota Business Corporation Act, except under certainspecified circumstances, from engaging in any merger, significant sale of stockor assets or business combination with any shareholder or group of shareholderswho own at least 10% of the Company’s common stock.

 

## ***Item1B.  UNRESOLVED STAFF COMMENTS***

 

None.

 

## ***Item2.  PROPERTIES***

 

**Aircraft**

 

*Mesaba*

The following table sets forth certaininformation as to Mesaba’s passenger aircraft fleet as of March 31, 2006:

 
| **Type of Aircraft** | ** ** | **Number of Aircraft** | ** ** | **Seating Capacity** | ** ** | **Approximate Single Flight Range (miles)** | ** ** | **Approximate Average Cruising Speed (mph)** | ** ** |
|----------------------|------------|------------------------|------------|----------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| Avro RJ85            |       | 23                     |       | 69                   |       | 1,400                                       |       | 400                                          |       |
| Saab 340             |       | 52                     |       | 30/34                |       | 500                                         |       | 300                                          |       |
| CRJ 200/440          |       | 2                      |       | 50                   |       | 1,500                                       |       | 500                                          |       |

 

Mesaba leases or subleases its Avro aircraftfrom Northwest under operating leases with initial terms of up to tenyears.  The lease and sublease agreementsfor the Avros with Northwest contain certain requirements of Mesaba regardingthe payment of taxes on the aircraft, acceptable use of the aircraft, the levelof insurance to be maintained, the maintenance procedures to be performed andthe condition of the aircraft upon their return to Northwest.  The ASA allows Mesaba to return Avros toNorthwest upon the occurrence of certain events, including termination of theASA.

 

Shortly after Northwest filed for bankruptcy,it unilaterally, and in breach of the ASA, removed 12 Avros from Mesaba’sflight schedule.  Mesaba and Northwestthen entered into a written agreement under which Northwest acknowledged thatMesaba was not required to make sublease payments on the idled aircraft.  That agreement expired in February 2006.  Mesaba chose to wait to reject the subleasesuntil it was confident that Northwest would not return the idled aircraft tothe flight schedule.  Mesaba discontinuedrecording rent expense of approximately $7.4 million on these Avros throughMarch 31, 2006 when they were idled at the request of Northwest.  In May 2006, Northwest formally rejected itsleases for these 12 idled Avros.  Toensure that Northwest’s actions have relieved Mesaba of all liability orobligations arising under the subleases, on June 13, 2006, Mesaba filed amotion with the Bankruptcy Court to seek formal approval of Mesaba’s rejectionof the subleases for the 12 idled aircraft. Mesaba believes that under Section 503(b)(1) of the Bankruptcy Code,which governs administrative claims, Northwest would have no standing to assertan administrative claim against Mesaba for the aircraft rent because Northwest 

 

 

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had previously agreed that Mesaba had noobligation to pay rent for grounded aircraft and because Mesaba parked andprotected the aircraft at Northwest’s request.

 

Mesaba leases its Saab aircraft eitherdirectly from leasing companies on a month-to-month basis or through subleaseswith Northwest under operating leases with initial terms of up to 17years.  The lease and sublease agreementswith the aircraft leasing companies and Northwest contain certain requirementsof Mesaba regarding the payment of taxes on the aircraft, acceptable use of theaircraft, the level of insurance to be maintained, the maintenance proceduresto be performed and the condition of the aircraft upon their return.  The ASA allows Mesaba to return Saab aircraftto Northwest upon the occurrence of certain events, including termination ofthe ASA.

 

Mesaba subleases its two CRJs from Northwestunder operating leases with initial terms of up to ten years.  The lease agreements contain certainrequirements of Mesaba regarding the payment of taxes on the aircraft,acceptable use of the aircraft, the level of insurance to be maintained, the maintenanceprocedures to be performed and the condition of the aircraft upon their returnto Northwest.  Northwest reimbursesMesaba’s aircraft rental expense in full under the ASA.  The ASA allows Mesaba to return CRJ aircraftto Northwest upon the occurrence of certain events, including termination ofthe ASA.

 

As of March 31, 2006, Mesaba’s existing fleetof Avro, Saab and CRJ aircraft had remaining lease terms of up to nineyears.  The current aggregate monthlylease payments for all Mesaba aircraft is approximately $7.0 million.  See further discussion in Item 7.

 

*Big Sky*

The following table sets forth certaininformation as to Big Sky’s passenger aircraft fleet as of March 31, 2006.

 
| **Type of Aircraft** | ** ** | **Number of Aircraft** | ** ** | **Seating Capacity** | ** ** | **Approximate Single Flight Range (miles)** | ** ** | **Approximate Average Cruising Speed (mph)** | ** ** |
|----------------------|------------|------------------------|------------|----------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|
| Operating:           |       |                   |       |                 |       |                                        |       |                                         |       |
| Beechcraft 1900D     |       | 10                     |       | 19                   |       | 750                                         |       | 325                                          |       |
| Nonoperating:        |       |                   |       |                 |       |                                        |       |                                         |       |
| Metro III            |       | 4                      |       |                 |       |                                        |       |                                         |       |

 

In January 2005, Big Sky entered into aletter of intent to lease ten Beechcraft 1900D aircraft from Mesa Airlines,Inc. (“Mesa”) to transition from its Metro fleet.  During March 2005, Big Sky parked fourMetros, took delivery of five Beechcraft aircraft and began flying them.  Big Sky took delivery of the remaining fiveBeechcraft aircraft during fiscal 2006, and the remaining Metro fleet wasremoved from service.  Big Sky continuesto dispose of the Metro aircraft through subleases or other means.  As of May 31, 2006, Big Sky has three Metroaircraft that are idled and pending disposition.

 

Big Sky leases its Metro aircraft fromAirLift Inc. and its Beechcraft aircraft from Mesa.  The lease agreements contain certainrequirements of Big Sky regarding the payment of taxes on the aircraft,acceptable use of the aircraft, the level of insurance to be maintained, themaintenance procedures to be performed and the condition of the aircraft upontheir return.

 

As of March 31, 2006, Big Sky’s fleet ofMetro and Beechcraft aircraft had remaining lease terms of 17 to 56 months andaggregate monthly lease payments of approximately $0.2 million.  The current aggregate monthly lease paymentsfor the nonoperating aircraft alone are approximately $0.1 million.  As 

 

 

22

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of March 31, 2006, the Company expensedapproximately $0.8 million related to the remaining lease payments on thenonoperating aircraft and other estimated net costs of the aircrafts’ return tothe lessor.

 

**Facilities**

 

*Holdings*

Holdings’ executive offices are located indowntown Minneapolis, Minnesota. Holdings leases approximately 3,370 square feet of office space withlease payments of approximately $6,000 per month.  The lease expires on September 30, 2010 butcontains an early termination provision allowing the lease to be cancelled onSeptember 30, 2007.

 

*Mesaba*

Mesaba leases an aircraft hangar facilityfrom the Metropolitan Airports Commission. Under this 25-year agreement, Mesaba leases approximately 366,000 squarefeet of maintenance facilities, maintenance offices, ramp, parking andunimproved land, of which approximately 87,000 square feet is for themaintenance hangar facility.  The leasepayments of approximately $111,000 per month commenced in October 2003.

 

Mesaba has a ten-year lease agreement forapproximately 33,000 square feet of office space for its principal executiveoffices located in Eagan, Minnesota.  Thelease payments of approximately $35,000 per month commenced in January2004.  The lease expires on December 31,2013 but contains an early termination provision allowing the lease to be cancelledat the end of seven years.

 

Mesaba subleases approximately 21,000 squarefeet of office and training support space at the Pan-Am International FlightAcademy in Eagan, Minnesota for its flight operations training center.  Mesaba pays approximately $27,000 per monthunder the terms of this sublease, which has a term of 15 years and expires inJanuary 2017.

 

In 1999, Mesaba entered into ground andfacilities leases for approximately 497,000 square feet of facilities, ramp,parking and unimproved land at the Cincinnati/Northern Kentucky InternationalAirport.  The facilities lease coversapproximately 126,000 square feet of hangar and maintenance space, and Mesabais obligated to pay monthly rentals of approximately $92,000 until July 1, 2029as part of a special facilities bond financing provided by theCincinnati/Northern Kentucky Airport Authority. The ground lease has a 30-year term concurrent with the facilities leaseand requires payments of approximately $12,000 per month.  Holdings has unconditionally guaranteedMesaba’s obligations related to the facility. Following its bankruptcy filing, Mesaba vacated the facility.  In accordance with its guaranty, Holdings hasbeen making the monthly ground and facilities lease payments.  Additionally, on February 15, 2006, Holdingsreceived notice that the trustee for the bondholders declared Holdings’guarantee for all sums to be immediately due and payable.  On April 18, 2006, Holdings entered into anagreement with UMB, the trustee for the bondholders, under which UMB agreed toforbear acceleration of Holdings’ guarantee obligations in exchange forHoldings delivering a letter of credit in the amount of $13.1 million to securethe payment of the obligations owed by Holdings to UMB.  See “Item 8. Financial Statements andSupplemental Data, Note 19 — Subsequent Events” for more information.

 

Mesaba leases approximately 334,000 squarefeet of ramp, parking and unimproved land at the Detroit MetropolitanAirport.  The hangar facility ofapproximately 60,000 square feet located on the property was paid in full infiscal 2003.  The ground lease has a20-year term with monthly lease payments of approximately $10,000.  Lease payments are subject to an annualadjustment on January 1 each year based upon the percentage change in an indexpublished by the Bureau of Labor Statistics of the United States Department ofCommerce.

 

 

23

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Mesaba leases approximately 38,000 squarefeet of hangar office space located on approximately 102,000 square feet ofland and parking areas of which Mesaba is ground lessee at the CentralWisconsin Airport in Mosinee, Wisconsin. Mesaba pays approximately $3,000 per month under the terms of the groundand facility leases, which expire on December 31, 2011, subject to two ten-yearrenewal options.

 

*Big Sky*

Big Sky’s main hangar and principal officesare located at the Logan International Airport in Billings, Montana.  The main facility consists of a 12,000 squarefoot building that can hold three aircraft for maintenance, a parts warehouse,back shop area and two floors of offices. A two-story building adjacent to the hangar houses Big Sky’s generaloffices.  These buildings are situated onapproximately 83,000 square feet of land owned by the City of Billings andleased to Big Sky on long-term facility and ground leases.  The facility lease has a 20-year term, andthe ground lease has a 26-year term.  Thecombined monthly lease payment is approximately $7,000.

 

## ***Item3.  LEGAL PROCEEDINGS***

 

*MesabaBankruptcy*

On October 13, 2005, Mesaba filed a voluntarypetition for relief under Chapter 11 of the United States Bankruptcy Code withthe United States Bankruptcy Court for the District of Minnesota.  The Bankruptcy Court is administering Mesaba’scase under the caption “In re Mesaba Aviation, Inc., dba Mesaba Airlines, CaseNo. 05/39258(GFK).”  Mesaba continues tooperate its business and manage its property as a debtor-in-possession pursuantto the Bankruptcy Code.  As a result ofthe Chapter 11 filing, attempts to collect, secure or enforce remedies withrespect to prepetition claims against Mesaba are subject to the automatic stayprovisions of Section 362(a) of the Bankruptcy Code, including the Mesabalitigation described below.

 

*SaabLeasing Litigation*

On October 4, 2002, Fairbrook Leasing, Inc.,Lambert Leasing, Inc. and Swedish Aircraft Holdings AB (“Saab Leasing”) filed adeclaratory judgment action against Mesaba relating to 20 Saab 340A (“340A”)aircraft leased by Mesaba.  Saab Leasingsought a judicial declaration that the terms of the leases applicable to eachof the 340A aircraft are governed by a March 7, 1996 term sheet proposal ratherthan the parties’ subsequent agreements and conduct.  In a December 8, 2003 order, the DistrictCourt for the District of Minnesota (the “District Court”) declared the termsheet proposal a binding preliminary agreement requiring Mesaba to negotiate ingood faith toward the execution of long-term agreements for each of the 340Aaircraft.  Mesaba appealed the DistrictCourt’s ruling.

 

On August 13, 2004, relying on the DistrictCourt’s declaratory judgment ruling, Saab Leasing filed a separate action inthe District Court alleging approximately $35 million in damages for past dueand future aircraft lease obligations. Mesaba denied the allegations in Saab Leasing’s complaint and contendedthat it had fulfilled and would continue to fulfill its existing obligations.

 

On May 19, 2005, the United States Court ofAppeals for the Eighth Circuit (the “Court of Appeals”) affirmed the DistrictCourt’s declaratory judgment ruling. Despite the Court of Appeals’ ruling, Mesaba believes, based on advicefrom its legal counsel, that it has defenses in the damages case that willlimit Saab Leasing’s ability to recover damages.  On September 9, 2005, the District Courtheard oral arguments on Saab Leasing’s and Mesaba’s cross-motions for summaryjudgment.  The District Court did notrule on these motions prior to Mesaba’s bankruptcy petition.

 

On October 14, 2005, Mesaba notified theDistrict Court that Mesaba applied for debtor protection under Chapter 11 ofthe Bankruptcy Code and that such application operates to automatically staythe 

 

 

24

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continuation of the Saab Leasing matter.  On January 19, 2006, the Bankruptcy Courtdenied Saab Leasing’s motion for relief from the automatic stay and held thatSaab Leasing could not continue with the case until at least May 1, 2006.  On June 16, 2006, the Bankruptcy Courtapproved Mesaba’s and Saab Leasing’s stipulation modifying the automatic stayfor the limited purpose of permitting the District Court to rule on thecross-motions for summary judgment. There can be no assurance that the District Court will grant Mesaba’smotion for summary judgment.  Therefore,the ultimate outcome of this dispute cannot be predicted with certainty.  Ultimately, the amount of any damages awardto Saab Leasing would be deemed an unsecured prepetition claim againstMesaba.  As of March 31, 2006, Mesaba hadnot established any accrual with regard to this litigation within its condensedfinancial statements (see “Item 8. Financial Statements and Supplemental Data,Note 20 — Financial Information of Mesaba”).

 

*OtherLitigation Matters*

Mesaba is also a defendant in variouslawsuits arising in the ordinary course of business.  While the outcome of these lawsuits andproceedings cannot be predicted with certainty, it is the opinion of Mesaba’smanagement based on current information and legal advice that the ultimate dispositionof these suits will not have a material adverse effect on the separatefinancial statements of Mesaba.

## ***Item4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS***

 

On March 9, 2006, the Company held its 2005annual meeting of shareholders, at which Donald E. Benson and Carl R. Pohladwere reelected as directors of the Company to serve until 2008.  The shareholders also ratified theappointment of Deloitte & Touche LLP to serve as the Company’s independentregistered public accounting firm for the fiscal year ending March 31,2006.  Mr. Benson received 18,726,131votes for his reelection and 448,568 against his reelection.  Mr. Pohlad received 19,031,640 votes for hisreelection and 143,059 votes against his reelection.  There were 19,071,990 votes cast forratification of Deloitte & Touche LLP, 87,783 votes cast againstratification, 14,926 abstentions and no broker non-votes.

 

## ***EXECUTIVEOFFICERS OF THE REGISTRANT***

 

**Paul F. Foley**, age 54, has been the President and ChiefExecutive Officer of the Holdings since October 1999 and was President andChief Executive Officer of Mesaba from October 1999 to September 2002.  He is also a director of Holdings.  He was Vice President at Atlas Air, Inc. fromDecember 1996 to September 1999.  Hepresently serves as a director of Zomax Incorporated.  Mr. Foley graduated with a bachelor ofscience degree from Cornell University and a master of business administrationdegree from Southern Methodist University in Dallas, Texas.

**Robert E. Weil**, age 41, has been Vice President, ChiefFinancial Officer and Treasurer of Holdings since January 2000 and also servedas Vice President, Chief Financial Officer of Mesaba from January 2000 toSeptember 2002.  Mr. Weil was the Managing Director of Finance - GroundOperation for Northwest Airlines from December 1997 until joiningHoldings.  He also held the position of Controller - Ground Operations andheld various other finance positions at Northwest since 1991.  Mr. Weil graduated with a bachelor of artsdegree in economics from Northwestern University and a master of managementdegree from J. L. Kellogg Graduate School of Management.

**Ruth M. Timm**, age 36,joined the Company in April 2005 as its Vice President, General Counsel.  Ms. Timm was General Counsel at IntegrisMetals, Inc. from October 2004 until February 2005, when the company was soldto a competitor.  Ms. Timm was anassociate in the corporate department of Leonard, Street and DeinardProfessional Association from October 2000 until September 2004, and anassociate at 

 

 

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Maun & Simon, PLC from September 1999 to October2000.  Ms. Timm served as a judicial lawclerk for the Honorable Paul A. Magnuson, Chief Judge, U.S. District Court forthe District of Minnesota from 1997 to 1999. She received her law degree from Valparaiso University School of Law in1997.

# **PART II**

 

## ***Item5.  MARKET FOR REGISTRANT’S COMMON EQUITYAND RELATED SHAREHOLDER MATTERS***

 

The Company’s common stock is traded underthe symbol “MAIR” on the Nasdaq National Market.

 

The following table sets forth, for theperiods indicated, the high and low price per share for the Company’s commonstock for the two most recent fiscal years. Quotations for such periods are as reported by Nasdaq for NationalMarket issues.  The Company has notissued cash dividends since September 1995 and does not currently intend to doso in the future.

 
| ** **  | ** ** | **Fiscal 2006** | ** ** | **Fiscal 2005** | ** ** |
|-------------|------------|-----------------|------------|-----------------|------------|
| **Quarter** | ** ** | **High**        | ** ** | **Low**         | ** ** | **High** | ** ** | **Low** | ** ** |
| First       |       | $               | 10.23      |            | $          | 8.50 |   | $ | 9.52 |   | $ | 7.11 |   |
| Second      |       | $               | 9.50       |            | $          | 5.67 |   | $ | 9.30 |   | $ | 7.55 |   |
| Third       |       | $               | 6.03       |            | $          | 4.50 |   | $ | 9.60 |   | $ | 8.11 |   |
| Fourth      |       | $               | 6.30       |            | $          | 4.61 |   | $ | 9.60 |   | $ | 7.97 |   |

 

On June 1, 2006, the number of holders ofrecord of common stock was 571.

 

The transfer agent for the Company’s commonstock is Wells Fargo Shareowner Services, 161 North Concord Exchange, South St.Paul, Minnesota, 55075-0738, telephone: (651) 450-4064.

 

**EquityCompensation Plan Information**

 
| ** **                         | ** ** | **Number of securities to be issued upon exercise of outstanding  options, warrants and rights** | ** ** | **Weighted-average exercise price of outstanding options, warrants and  rights** | ** ** | **Number of securities remaining available for future issuance under  equity compensation plans (excluding securities reflected in column (a))** | ** ** |
|------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Plan Category**                  | ** ** | **(a)**                                                                                          | ** ** | **(b)**                                                                          | ** ** | **(c)**                                                                                                                                          | ** ** |
| Plans approved by security holders |       | 5,671,676                                                                                        |       | 8.22                                                                             |       | $                                                                                                                                                | 1,327,965  |   |
|                                    |            |                                                                                                  |            |                                                                                  |            |                                                                                                                                                  |            |  |

 

The equity compensation plans approved by theCompany’s shareholders are the 1994 Stock Option Plan, the 1996 Director StockOption Plan and the 2000 Stock Incentive Plan. The 2000 Stock Incentive Plan contains a provision that automaticallyincreases the authorized shares available for grant on September 1 of each yearby the lesser of 300,000 or 1% of the then outstanding common shares.  See “Item 8. Financial Statements andSupplemental Data, Note 11 — Shareholders’ Equity” for additional informationregarding the Company’s equity compensation plans.

 

 

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## ***Item6.  SELECTED FINANCIAL DATA***

 

The following tables set forth selectedfinancial data with respect to the Company as of the dates and for the periodsindicated.  The selected financial datahas been derived from the Company’s audited consolidated financial statements,which have been restated to give effect to the restatement discussed in “Item8. Financial Statements and Supplemental Data, Note 16 — Restatement.”  As of the Petition Date, the accounts ofMesaba were deconsolidated from the Company’s consolidated financialstatements.  Therefore, the financialdata below excludes Mesaba from the Petition Date forward.  The financial data set forth below should beread in conjunction with the Company’s Consolidated Financial Statements andNotes thereto and “Item 7. Management’s Discussion and Analysis of FinancialCondition and Results of Operations.”

 
| **Statement of Operations Data: **                                            | ** ** | **For the Years Ended March 31  (in thousands, except share data)** | ** **      |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|-----------------|
| ** **                                                                         | ** ** | ** **                                                          | **As restated** | ** ** |
| ** **                                                                         | **2006**   | ** **                                                          | **2005**        | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                         | ** ** | ** **                                                          | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating revenues                                                                 |       | $                                                                   | 256,279         |   | $ | 442,610 |   | $ | 432,789 |   | $ | 456,880 |   | $ | 416,913 |   |
| Operating expenses                                                                 |       | 318,980                                                             |            | 433,971 |   | 428,763 |   | 448,549 |   | 416,077 |   |
| Operating (loss) income                                                            |       | $                                                                   | (62,701         | ) | $ | 8,639 |   | $ | 4,026 |   | $ | 8,331 |   | $ | 836 |   |
|                                                                               |       |                                                                |            |   |   |   |   |   |   |   |   |
| Equity in loss of Mesaba Aviation, Inc.                                            |       | $                                                                   | (39,953         | ) | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
|                                                                               |       |                                                                |            |   |   |   |   |   |   |   |   |
| Net (loss) income                                                                  |       | $                                                                   | (82,848         | ) | $ | 7,355 |   | $ | 4,496 |   | $ | 4,151 |   | $ | 7,828 |   |
|                                                                               |       |                                                                |            |   |   |   |   |   |   |   |   |
| Net (loss) income per share-basic                                                  |       | $                                                                   | (4.02           | ) | $ | 0.36 |   | $ | 0.22 |   | $ | 0.20 |   | $ | 0.39 |   |
| Weighted average number of issued shares outstanding-basic                         |       | 20,584                                                              |            | 20,505 |   | 20,334 |   | 20,308 |   | 20,289 |   |
|                                                                               |       |                                                                |            |   |   |   |   |   |   |   |   |
| Net (loss) income per share-diluted                                                |       | $                                                                   | (4.02           | ) | $ | 0.35 |   | $ | 0.22 |   | $ | 0.20 |   | $ | 0.38 |   |
| Weighted average common and potentially dilutive common shares outstanding-diluted |       | 20,584                                                              |            | 21,050 |   | 20,562 |   | 20,357 |   | 20,601 |   |

 

 

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| **Balance Sheet Data:**                         | ** ** | **As of March 31 (in thousands)** | ** ** |
|-------------------------------------------------|------------|-----------------------------------|------------|
|                                            | **2006**   | ** **                        | **2005**   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** |   |
|                                            |       |                              |       |   |   |   |   |   |   |   |   |
| Current assets                                  |       | $                                 | 98,436     |   | $ | 187,547 |   | $ | 174,934 |   | $ | 158,976 |   | $ | 162,621 |   |
| Property and equipment, net                     |       | 1,423                             |       | 38,421 |   | 39,722 |   | 43,798 |   | 50,615 |   |
| Long-term investments                           |       | 19,484                            |       | 43,240 |   | 39,984 |   | 32,162 |   | 4,068 |   |
| Other noncurrent assets, net                    |       | 2,599                             |       | 11,746 |   | 14,167 |   | 15,052 |   | 8,758 |   |
| Total assets                                    |       | $                                 | 121,942    |   | $ | 280,954 |   | $ | 268,807 |   | $ | 249,988 |   | $ | 226,062 |   |
|                                            |       |                              |       |   |   |   |   |   |   |   |   |
| Current liabilities                             |       | $                                 | 12,571     |   | $ | 82,206 |   | $ | 77,098 |   | $ | 65,372 |   | $ | 44,781 |   |
| Other noncurrent liabilities                    |       | 772                               |       | 6,069 |   | 7,448 |   | 7,161 |   | 8,221 |   |
| Shareholders’ equity                       |       | 108,599                           |       | 192,679 |   | 184,261 |   | 177,455 |   | 173,060 |   |
| Total liabilities and shareholders’ equity |       | $                                 | 121,942    |   | $ | 280,954 |   | $ | 268,807 |   | $ | 249,988 |   | $ | 226,062 |   |

 

Like other air carriers, Mesaba disclosesinformation regarding passengers, revenue passenger miles, available seatmiles, load factor and revenue per available seat mile in “Selected OperatingData” below.  While this data is oftenused to assess the financial performance of a major carrier, for a regionalcarrier such as Mesaba operating under a capacity purchase agreement, this datais not directly relevant to Mesaba’s revenues or profitability.  However, it is provided to indicate the sizeand scope of Mesaba’s operations.

 
| ** **                                                | ** ** | **For the Years Ended March 31** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                | ** ** | **2006**                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Selected Operating Data:                                  |       |                             |       |   |   |   |   |   |   |   |   |
| *Mesaba*                                                  | * *   | * *                         | * *   | * * | * * | * * | * * | * * | * * | * * | * * |
| Passengers                                                |       | 5,452,424                        |       | 5,623,731 |   | 5,596,721 |   | 5,658,006 |   | 5,650,500 |   |
| Available seat miles (1)                                  |       | 2,755,577                        |       | 3,064,167 |   | 2,904,198 |   | 2,822,140 |   | 2,739,946 |   |
| Revenue passenger miles (2)                               |       | 1,861,110                        |       | 2,003,910 |   | 1,774,931 |   | 1,646,114 |   | 1,571,042 |   |
| Load factor (3)                                           |       | 67.5                             | %          | 65.4 | % | 61.1 | % | 58.3 | % | 57.3 | % |
| Block hours flown                                         |       | 274,727                          |       | 290,345 |   | 290,270 |   | 300,049 |   | 298,349 |   |
| Departures                                                |       | 198,035                          |       | 207,067 |   | 219,009 |   | 233,160 |   | 240,068 |   |
| Revenue per ASM (4)                                       |       | 0.148                            |       | 0.140 |   | 0.143 |   | 0.160 |   | 0.152 |   |
| Cost per ASM (4)                                          |       | 0.163                            |       | 0.135 |   | 0.140 |   | 0.155 |   | 0.152 |   |
| Cost per ASM (excluding impairment and other charges) (4) |       | 0.152                            |       | 0.135 |   | 0.140 |   | 0.155 |   | 0.152 |   |
|                                                      |       |                             |       |   |   |   |   |   |   |   |   |
| *Big Sky (5)*                                             |       |                             |       |   |   |   |   |   |   |   |   |
| Passengers                                                |       | 113,525                          |       | 85,455 |   | 105,913 |   | 39,587 |   |   |   |
| Available seat miles (1)                                  |       | 77,786                           |       | 59,284 |   | 75,188 |   | 29,810 |   |   |   |
| Revenue passenger miles (2)                               |       | 32,193                           |       | 21,630 |   | 27,066 |   | 10,630 |   |   |   |
| Load factor (3)                                           |       | 41.4                             | %          | 36.5 | % | 36.0 | % | 35.7 | % |   |   |
| Block hours flown                                         |       | 20,839                           |       | 16,396 |   | 20,307 |   | 9,456 |   |   |   |
| Departures                                                |       | 21,615                           |       | 19,423 |   | 23,245 |   | 8,415 |   |   |   |
| Revenue per ASM (4)                                       |       | 0.263                            |       | 0.254 |   | 0.219 |   | 0.193 |   |   |   |
| Cost per ASM (4)                                          |       | 0.363                            |       | 0.337 |   | 0.267 |   | 0.262 |   |   |   |
| Cost per ASM (excluding impairment and other charges) (4) |       | 0.331                            |       | 0.337 |   | 0.267 |   | 0.262 |   |   |   |

----

(1) ASM are determined by multiplying thenumber of seats available for passengers by the number of miles flown.  Amounts are in thousands.

 

(2) Revenue passenger miles are determined bymultiplying the number of fare-paying passengers carried by the distanceflown.  Amounts are in thousands.

 

(3) Load factor is determined by dividingrevenue passenger miles by available seat miles.

 

28

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(4)          Revenue per ASMand cost per ASM for fiscal 2005 and 2004 have been restated to giveeffect to the restatement discussed in “Item 8. Financial Statements andSupplemental Data, Note 16 - Restatement.”

 

(5)          Big Sky waspurchased by the Company in December 2002. Operating data for fiscal 2003 is from the date of purchase to March 31,2003.

 

## ***Item7.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS***

 

Management’s Discussion and Analysis ofFinancial Condition and Results of Operations has been restated to give effectto the restatement discussed in “Item 8. Financial Statements and SupplementalData, Note 16 — Restatement,” and should be read in conjunction with theaccompanying consolidated financial statements. The Company’s operations and financial results are subject to variousrisks and uncertainties as discussed in “Item 1A.  Risk Factors.”

 

**Year inReview and Outlook**

 

*Summary*

Fiscal 2006 is best summarized by reviewingthe year in two distinct periods: the time before and the time after theNorthwest bankruptcy in September 2005. Prior to Northwest declaring bankruptcy, Mesaba was focused on addingthe CRJ to its certificate and completing the new omnibus ASA withNorthwest.  The new ASA extended the Saaband Avro agreements past 2007 to 2015 and provided for 15 new CRJ aircraft.  Mesaba maintained its outstanding operatingperformance throughout the summer and received FAA certification for the CRJ inless than six months.  In recognition ofits strong commitment to safety and loss prevention programs, Mesaba wasawarded the AIG Operational Excellence Award during the summer of 2005.  Two CRJs entered Mesaba’s fleet in the firstweek of September 2005, and Mesaba began operating them in October 2005.  Throughout the summer, Mesaba alsoimplemented a contingency plan to ensure that Northwest’s mechanics’ strike inAugust 2005 did not impact Mesaba’s operations.

 

On September 14, 2005, Northwest filed forbankruptcy protection under Chapter 11 of the Bankruptcy Code.  Northwest missed two payments to Mesaba inSeptember 2005 for services between August 15 and September 14.  Since its bankruptcy filing, Northwest hasalso implemented various changes to Mesaba’s fleet, including idling nine ofthe Avros operated by Mesaba effective October 31, 2005 and three additionalAvros and 11 Saabs effective January 4, 2006.

 

Northwest’s missed payments and its subsequentchanges to Mesaba’s fleet adversely affected Mesaba and ultimately resulted inMesaba filing for bankruptcy protection on October 13, 2005.  Following its bankruptcy filing, Mesaba’sfocus moved from adding the CRJ to its fleet to implementing a bankruptcystrategy to reduce its labor and non-labor costs and to emerge as a competitiveregional airline that will be able to provide quality regional airlineservices.

 

Following fiscal 2006 year end, Northwestremoved two more Saabs and seven additional Avros effective June 8, 2006.  Northwest has indicated its intent to removeall of the remaining aircraft, other than 49 Saabs, from Mesaba’s fleet byDecember 31, 2006, subject to final lease negotiations between Northwest andits lessors.  As of June 8, 2006, Mesabawas operating a total of 16 Avros, 50 Saabs and two CRJs.  Finally, Northwest issued a request forproposal for flying up to 126 CRJs in December 2005.  Mesaba 

 

 

29

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has submitted a bid for additional CRJs, butrealizes that many of its competitors have also submitted bids to operate suchaircraft.

 

Separately, Big Sky completed its fleettransition, bringing on ten Beechcraft 1900Ds and retiring the Metros. Theaftermath of the major hurricanes in the summer and fall of 2005 and theresulting increase in fuel prices negatively impacted Big Sky’s financialresults and led to the recording of a $2.5 million goodwill impairment charge.

 

*Outlook*

As the airline industry continues through itstransformation, the Company and its subsidiaries will focus its efforts infiscal 2007 on four main strategies:

 

Mesaba

•                  Mesaba willattempt to execute its bankruptcy reorganization strategy, which includesdownsizing its fleet to 49 Saabs, achieving significant cost savings, includingboth labor and non-labor expenses and affirming its business relationship withNorthwest by either assuming the existing ASA or negotiating a new ASA.

 

•                  Mesaba willthen attempt to develop a plan of reorganization to successfully emerge frombankruptcy as a competitive low-cost supplier of regional flights.

 

BigSky

•                  Big Sky willfocus on growing its Beechcraft 1900D operation by bidding on additional EASflying and looking for other opportunities to expand its fleet.

 

Holdings

•                  Holdings willexplore additional growth opportunities and will consider acquisitions todiversify both within and outside the airline industry.

 

**Fiscal Year Ended March 31, 2006Compared with Fiscal Year Ended March 31, 2005**

 

*EarningsSummary*

The Company reported a consolidated net lossof $82.8 million, or $4.02 per basic and diluted share, for fiscal 2006,compared to net income of $7.4 million, or $0.35 per diluted share, in fiscal2005.  To allow for a more direct andmeaningful comparison, Mesaba’s results of operations have been analyzed forthe entire fiscal years ended March 31, 2006 and 2005 not withstanding thedeconsolidation of Mesaba from the Company’s consolidated financial statementsas of October 13, 2005, the date of Mesaba’s bankruptcy filing.  Mesaba’s condensed financial statements on astand-alone basis are presented in “Item 8. Financial Statements andSupplemental Data, Note 20 — Financial Information of Mesaba.”

 

*Mesaba*

MesabaOperating Revenues

Total operating revenues decreased 4.4% infiscal 2006 to $408.8 million from $427.5 million in fiscal 2005.  The decrease was due primarily to a drop inAvro revenue of $24.9 million or 12.7% as a result of 12 Avros removed from theschedule by Northwest between October 31, 2005 and January 4, 2006.  Avro block hours for fiscal 2006 were down15.6%.  Saab revenue decreased $0.9million, or 0.4%, in fiscal 2006 compared to fiscal 2005 primarily due to adecrease in Saab ASMs of 2.8% and an increase in the fuel offset to revenueyear over year.  The decline in Saabrevenue was partially offset by an increase in rate per ASM of 4.1% and anincrease in the passenger stipend due to an increased number of passengersflying the Saab aircraft.  The decreasein Saab and Avro revenue was offset in part by the additional 

 

 

30

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revenue generated by the two new CRJ aircraftof $5.5 million and additional ground handling revenue of $1.1 million.

 

MesabaOperating Expenses

Total operating expenses in fiscal 2006 increased8.7% to $448.9 million from $413.1 million in fiscal 2005.  The cost per ASM increased 20.7% to $0.163 infiscal 2006 from $0.135 in fiscal 2005. The following table compares components of operating cost per ASM forthe years ended March 31:

 
| ** **                    | ** ** | **Operating Expenses** | ** ** | **Operating Cost Per ASM** | ** ** |
|-------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                    | ** ** | **2006**               | ** ** | **2005**                   | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Wages and benefits            |       | $                      | 145,495    |                       | $          | 140,871 |   | $ | 4,624 |   | 3.3 | % | 5.3 | ¢ | 4.6 | ¢ |
| Aircraft maintenance          |       | 83,368                 |       | 81,860                     |       | 1,508 |   | 1.8 | % | 3.0 |   | 2.7 |   |
| Aircraft rents                |       | 92,948                 |       | 100,502                    |       | (7,554 | ) | (7.5 | )% | 3.4 |   | 3.3 |   |
| Landing fees                  |       | 9,333                  |       | 9,959                      |       | (626 | ) | (6.3 | )% | 0.3 |   | 0.3 |   |
| Insurance and taxes           |       | 6,346                  |       | 6,156                      |       | 190 |   | 3.1 | % | 0.2 |   | 0.2 |   |
| Depreciation and amortization |       | 12,243                 |       | 13,844                     |       | (1,601 | ) | (11.6 | )% | 0.4 |   | 0.5 |   |
| Administrative and other      |       | 68,000                 |       | 59,885                     |       | 8,115 |   | 13.6 | % | 2.6 |   | 1.9 |   |
| Impairment and other charges  |       | 31,206                 |       | —                     |       | 31,206 |   | N/M |   | 1.1 |   | 0.0 |   |
|                          |       | $                      | 448,939    |                       | $          | 413,077 |   | $ | 35,862 |   | 8.7 | % | 16.3 | ¢ | 13.5 | ¢ |

 

Wages and benefits increased 3.3% to $145.5million in fiscal 2006 from $140.9 million in fiscal 2005.  The significant factors contributing to thisincrease were an increase in health and dental expenses of $3.2 million,increased personnel and other costs related to additional ground handling andcustomer service of $1.8 million primarily due to increased handling inDetroit, and an increase in pilot training of $1.4 million.  These increases were partially offset by adecrease of $0.6 million for the 401(k) benefit plan primarily due to increasedcosts in the prior year for a voluntary compliance program settlement with theInternal Revenue Service related to incorrect vesting and matchingcontributions in prior years and reduced incentive compensation of $2.4million.

 

Aircraftmaintenance costs, excluding wages and benefits, increased 1.8% to $83.4million in fiscal 2006 from $81.9 million in fiscal 2005.  Aircraft maintenance costs increasedprimarily due to additional costs related to a rate adjustment for accruals foraircraft checks and additional rotable repairs. These increases were partially offset by maintenance expense reductionsdriven by a 5.5% reduction in total block hours.

 

Aircraft rents decreased 7.5% to $92.9million in fiscal 2006 from $100.5 million in fiscal 2005.  This decrease is attributable to the 12 Avrosidled by Northwest ($7.4 million) and the 11 Saabs removed from service inJanuary 2006 due to certain Mesaba leases with Pinnacle being rejected ($2.0million), partially offset by the addition of two CRJs ($1.3 million).

 

Landingfees decreased 6.3% to $9.3 million in fiscal 2006 from $10.0 million in fiscal2005 due to reduced flying.  AlthoughNorthwest is responsible for the Avro landing fees for Mesaba’s operations,Mesaba pays several airports directly and Northwest reimburses Mesaba for suchpayments.  The reimbursement fromNorthwest for these Avro landing fees was $2.9 million and $3.5 million infiscal 2006 and 2005, respectively, and is recorded as both landing feesexpense and passenger revenue in Mesaba’s condensed statements of operations.

 

Insurance and taxes increased 3.1% from $6.2million in fiscal 2005 to $6.3 million in fiscal 2006.  The increase isdue to a one-time credit of $0.8 million received in fiscal 2005 for propertytax reimbursement from Northwest.  These increases were offset by lowerhull and passenger insurance of $0.7 million due to reduced rates,the smaller fleet size and reduced number of passengers.

 

 

31

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Depreciation and amortization decreased 11.6%to $12.2 million in fiscal 2006 compared to $13.8 million in fiscal 2005.  The lower level of depreciation andamortization resulted from reduced capital spending over the last several yearsand reduced fleet size.

 

Administrative and other expenses increased13.6% to $68.0 million in fiscal 2006 from $59.9 million in fiscal 2005.  Significant factors resulting in thisincrease were an increase of $2.7 million primarily related to pilot andmechanic training in preparation for the CRJ fleet, an increase of $2.6 millionprimarily related to additional repairs by outside vendors and the contingencyplan to ensure that Northwest’s mechanics’ strike did not impact Mesaba’soperations, an increase of $0.7 million primarily related to ground handlingand an increase of $1.0 million primarily related to the increased use ofcontract employees.

 

Impairmentand other charges of $31.2 million were recorded in fiscal 2006 as a result ofestablishing a $29.1 million reserve for the unsecured prepetition receivablesdue from Northwest (net of certain offsetting liabilities) due to the September2005 bankruptcy filing by Northwest and a $2.1 million write-off of theremaining unamortized net book value of the warrants related to the priorAirlink and Jet Agreements with Northwest.

 

Mesabaincurred fuel expenditures of $19.2 million, or 0.7 cents per ASM, in fiscal2006 compared to $16.9 million, or 0.6 cents per ASM, in fiscal 2005.  In accordancewith EITF Issue No. 99-19, *Reporting Revenue Gross asa Principal vs. Net as an Agent*, these costs are classified as areduction from revenue in Mesaba’s condensed statements of operations.  Mesaba’s actual cost of fuel for the Saabaircraft, including taxes and pumping fees, was 83.5 cents per gallon.  Mesaba’s actual cost of fuel for the CRJs,including taxes and pumping fees, was 70 cents per gallon.  These prices are fixed under the terms of theASA, thereby insulating Mesaba from fluctuations in the market price of fuel.  Northwest is responsible for all fuel forMesaba’s Avro operations.

 

*Big Sky*

BigSky Operating Revenues

Totaloperating revenues increased 35.1% to $20.4 million in fiscal 2006 from $15.1million in fiscal 2005.  New fiscal 2006service between Sheridan, Wyoming and Denver, Colorado, Bozeman,Montana, Pocatello, Idaho, Walla Walla, Washington and Boise, Idaho contributedto the 27.1% increase in flying.  Thesystem experienced an increase of 4.9 load factor points and a 17.6% increasein average fare in fiscal 2006 compared to fiscal 2005.

 

Other revenues increased 14.8% as a result ofa new EAS subsidy contract for service between Sheridan, Wyoming and Denver,Colorado and an improvement in flight completion of 2.5 points.   Fiscal 2006 includes ground handling revenueand a short-term wet lease operation provided by Big Sky generating $0.3million.

 

 

32

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BigSky Operating Expenses

Totaloperating expenses in fiscal 2006 increased 41.2% to $28.2 million from $20.0million in fiscal 2005.  The followingtable compares components of operating cost per ASM for the years ended March31:

 
| ** **                    | ** ** | **Operating Expenses** | ** ** | **Operating Cost Per ASM** | ** ** |
|-------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                    | ** ** | **2006**               | ** ** | **2005**                   | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Wages and benefits            |       | $                      | 7,484      |                       | $          | 6,195 |   | $ | 1,289 |   | 20.8 | % | 9.6 | ¢ | 10.4 | ¢ |
| Aircraft  fuel                |       | 4,826                  |       | 2,471                      |       | 2,355 |   | 95.3 | % | 6.2 |   | 4.2 |   |
| Aircraft maintenance          |       | 3,302                  |       | 2,416                      |       | 886 |   | 36.7 | % | 4.2 |   | 4.1 |   |
| Aircraft rents                |       | 2,014                  |       | 1,976                      |       | 38 |   | 1.9 | % | 2.6 |   | 3.3 |   |
| Landing fees                  |       | 340                    |       | 249                        |       | 91 |   | 36.5 | % | 0.4 |   | 0.4 |   |
| Insurance and taxes           |       | 390                    |       | 510                        |       | (120 | ) | (23.5 | )% | 0.5 |   | 0.9 |   |
| Depreciation and amortization |       | 878                    |       | 774                        |       | 104 |   | 13.4 | % | 1.1 |   | 1.3 |   |
| Administrative and other      |       | 6,488                  |       | 5,400                      |       | 1,088 |   | 20.1 | % | 8.4 |   | 9.1 |   |
| Impairment and other charges  |       | 2,503                  |       | —                     |       | 2,503 |   | N/M |   | 3.3 |   | 0.0 |   |
|                          |       | $                      | 28,225     |                       | $          | 19,991 |   | $ | 8,234 |   | 41.2 | % | 36.3 | ¢ | 33.7 | ¢ |

 

During fiscal 2006, wages and benefitsincreased due to changes in the workers’ compensation coverage and the additionof 44 new pilots and customer service agents due to new service offerings.  In fiscal 2006, Big Sky paid actual claimscompared to having claims covered by insurance in fiscal 2005.  In fiscal 2005, Big Sky recorded a reservefor remaining open workers’ compensation claims from the previous policyperiod.

 

Aircraft fuel represented the largest expenseincrease, 95.3%, from fiscal 2005 to fiscal 2006.  The number of gallons of fuel burnedincreased approximately 70% due to added flight hours and the Beechcraft 1900Daircraft’s higher consumption per hour. Additionally, the average price per gallon of fuel increased 15% to$1.98 in fiscal 2006 from $1.71 in fiscal 2005.

 

Aircraft maintenance increased 36.7% due toincreased flying year-over-year.  Blockhours increased 27.1%, and ASMs increased 31.2% from fiscal 2005 to fiscal2006.

 

Aircraft rents increased 1.9% due to six Beechcraft aircraft brought online while three Metro aircraft were retired. During fiscal 2006, a total of ten Beechcraft aircraft and four Metroaircraft were leased compared to four Beechcraft and 14 Metro aircraft beingleased during fiscal 2005.

 

The decrease in insurance and taxes was theresult of a property tax adjustment in fiscal 2005.

 

Administrative and other expenses increased20.1%, or $1.1 million, in fiscal 2006 over fiscal 2005.  Credit card commissions increased $0.1million and computer reservation system charges increased $0.2 million infiscal 2006 as a result of a 32.8% increase in passengers.  In addition, Big Sky recorded $0.8 million inexpense associated with the return of non-operating Metro aircraft.

 

Fiscal 2006 contained a $2.5 million goodwillimpairment charge.  The impairment wasdetermined by comparing the fair value of the intangible asset to the currentcarrying value.

 

*Holdings*

HoldingsOperating Expenses

Totaloperating expenses in fiscal 2006 increased to $21.1 million from $5.7 millionin fiscal 2005, primarily due to $13.7 million in impairment and other charges,consisting of an $8.9 million write-off of Holdings’ equity investment in itsMesaba subsidiary and a $4.8 million charge associated with Holdings’ 

 

 

33

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guarantyof Mesaba’s facilities and ground lease for its facility at theCincinnati/Northern Kentucky International Airport.

 

*ConsolidatedOperating Income*

Operating losses totaled $62.7 million infiscal 2006, as compared to operating income of $8.6 million in fiscal2005.  The Company’s operating margindecreased to (24.5)% in fiscal 2006 from 1.9% in fiscal 2005.

 

*ConsolidatedNonoperating Income*

Nonoperating income (net) increased to $6.0million for fiscal 2006 from $2.3 million in fiscal 2005.  The increase is primarily due to increasedinterest income as a result of higher rates earned on cash and investments anda $1.8 million arbitration settlement with an investment advisor in the firstquarter of fiscal 2006.

 

*ConsolidatedProvision for Income Taxes*

The Company recorded a tax benefit of $13.8million in fiscal 2006 compared to a provision for income taxes of $3.6 millionin fiscal 2005.  The Company’s blendedeffective tax rate was (24.4)% in fiscal 2006, after the deconsolidation ofMesaba’s financial results from the Company’s consolidated financial statementsas of October 13, 2005, the date of Mesaba’s bankruptcy filing, as compared to32.9% in fiscal 2005, which includes the financial results of Mesaba. In fiscal2006, the Company booked a valuation allowance against its net deferred taxassets of $3.6 million.  The effectivetax rate would have been (30.8)% exclusive of the valuation allowance.  During the first quarter of fiscal 2005, theCompany received verification of a final settlement with the Internal RevenueService concerning its examination of the Company’s fiscal 1995 and 1996 incometax returns.  As a result of thissettlement, the Company reduced its income tax payable and tax provision by$1.2 million.  Without this adjustment,the Company’s effective tax rate would have been 43.8% in fiscal 2005.

 

**FiscalYear Ended March 31, 2005 Compared with Fiscal Year Ended March 31, 2004**

 

*EarningsSummary*

The Company reported net income of $7.4million, or $0.35 per diluted share, for fiscal 2005, compared to $4.5 million,or $0.22 per diluted share, in fiscal 2004. Diluted weighted average common and potentially dilutive common shareswere 21.1 million and 20.6 million in fiscal 2005 and 2004.

 

*Mesaba*

MesabaOperating Revenues

Total operating revenues increased 2.7% infiscal 2005 to $427.5 million from $416.3 million in fiscal 2004.  The increase was primarily attributable toincremental ground handling revenue due to Mesaba’s increased ground handlingbusiness in Minneapolis and Detroit. This was partially offset by a 0.4% decrease in passenger revenue as thereduction in Saab flying more than offset the incremental Avro flying year-over-year.

 

 

34

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MesabaOperating Expenses

Totaloperating expenses in fiscal 2005 increased 1.7% to $413.1 million from $406.1million in fiscal 2004.  The cost per ASMdecreased 2.2% to $0.135 from $0.138. The following table compares components of operating cost per ASM forthe years ended March 31:

 
| ** **                    | ** ** | **Operating Expenses** | ** ** | **Operating Cost Per ASM** | ** ** |
|-------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                    | ** ** | **2005**               | ** ** | **2004**                   | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Wages and benefits            |       | $                      | 140,871    |                       | $          | 133,454 |   | $ | 7,417 |   | 5.6 | % | 4.6 | ¢ | 4.6 | ¢ |
| Aircraft maintenance          |       | 81,860                 |       | 77,381                     |       | 4,479 |   | 5.8 | % | 2.7 |   | 2.7 |   |
| Aircraft rents                |       | 100,502                |       | 103,011                    |       | (2,509 | ) | (2.4 | )% | 3.3 |   | 3.5 |   |
| Landing fees                  |       | 9,959                  |       | 10,603                     |       | (644 | ) | (6.1 | )% | 0.3 |   | 0.4 |   |
| Insurance and taxes           |       | 6,156                  |       | 8,366                      |       | (2,210 | ) | (26.4 | )% | 0.2 |   | 0.3 |   |
| Depreciation and amortization |       | 13,844                 |       | 16,299                     |       | (2,455 | ) | (15.1 | )% | 0.5 |   | 0.6 |   |
| Administrative and other      |       | 59,885                 |       | 57,048                     |       | 2,837 |   | 5.0 | % | 1.9 |   | 1.9 |   |
|                          |       | $                      | 413,077    |                       | $          | 406,162 |   | $ | 6,915 |   | 1.7 | % | 13.5 | ¢ | 14.0 | ¢ |

 

Wages and benefits increased 5.6% to $140.9million in fiscal 2005 from $133.5 million in fiscal 2004.  Wages and benefits increased due to increasedground handling wages from additional ground handling activity, increased wagesdue to additional flying and the new pilots’ contract and increased costsrelated to the 401(k) benefit plan. These increases were slightly offset by lower health and dental expensesresulting from improved experience. Year-over-year comparisons were also affected by the one-time $2.7million retroactive pilot compensation expenses in the prior year resultingfrom the pilots’ contract signed in January 2004.

 

Aircraft maintenance, excluding wages andbenefits, increased 5.8% to $81.9 million in fiscal 2005 from $77.4 million infiscal 2004.  Aircraft maintenance costsincreased primarily due to a 9.5% increase in Avro block hours in fiscal 2005and repair costs incurred to continue to maintain the fleet as it ages.

 

Aircraft rents decreased 2.4% to $100.5million in fiscal 2005 from $103.0 million in fiscal 2004.  This decrease is attributable to four fewerSaab aircraft in service year-over-year.

 

Landingfees decreased 6.1% to $10.0 million in fiscal 2005 from $10.6 million infiscal 2004.  The decrease is primarilyattributable to the 7.1% reduction of Saab departures partially offset byairport rate increases during fiscal 2005. Although Northwest is responsible for the Avro landing fees for Mesaba’soperations, Mesaba pays several airports directly and Northwest reimbursesMesaba for such payments.  Thereimbursement from Northwest for these Avro landing fees was $3.5 million and$3.8 million for the fiscal years ended March 31, 2005 and 2004, respectively,and is recorded as both landing fees expense and passenger revenue in Mesaba’scondensed statements of operations.

 

Insurance and taxes decreased 26.4% to $6.2million in fiscal 2005 from $8.4 million in fiscal 2004.  The decrease is primarily attributable tofewer insured aircraft and a reduction in the rates charged for hull and passengerliability insurance, as well as the recognition of property tax refunds of $0.7million.

 

Depreciation and amortization decreased 15.1%to $13.8 million in fiscal 2005 compared to $16.3 million in fiscal 2004.  The lower level of depreciation andamortization resulted from reduced capital spending over the last severalyears.

 

Administrative and other expenses increased5.0% to $59.9 million in fiscal 2005 from $57.0 million in fiscal 2004primarily due to increased outside services of $3.6 million related toconsulting and audit costs incurred to comply with the requirements of theSarbanes-Oxley Act and increased TSA fees. In addition, the increase was due to costs associated with flightcancellations of approximately $1.2 million. 

 

 

35

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These increased costs were offset by reducedcosts related to third party Saab ground handling of $1.1 million and pilottraining of $1.4 million.

 

Mesabaincurred fuel expenditures of $16.9 million, or 0.6 cents per ASM, in fiscal2005 compared to $20.1 million, or 0.7 cents per ASM, in fiscal 2004.  In accordancewith EITF Issue No. 99-19, *Reporting Revenue Gross asa Principal vs. Net as an Agent*, these costs are classified as areduction from revenue in Mesaba’s condensed statements of operations.  Mesaba’s actual cost of fuel for the Saabaircraft, including taxes and pumping fees, was 83.5 cents per gallon.  These prices are fixed under the terms of theASA, thereby insulating Mesaba from fluctuations in the market price offuel.  Northwest is responsible for allfuel for Mesaba’s Avro operations.

 

*Big Sky*

BigSky Operating Revenues

Total operating revenues decreased 8.5% to$15.1 million in fiscal 2005 from $16.5 million in fiscal 2004 due to areduction in flying unprofitable routes, resulting in a $1.7 million decreasein passenger revenue, partially offset by a $0.3 million increase in EASsubsidies.

 

BigSky Operating Expenses

Total operating expenses in fiscal 2005decreased 0.5% to $20.0 million from $20.1 million in fiscal 2004 primarily dueto the reduced flying year-over-year, which was offset by $1.0 million in costsassociated with the permanent grounding of four Metro aircraft:  three due to the fleet transition from Metrosto Beechcraft 1900Ds and one due to significant aircraft damage.  The following table compares components ofoperating cost per ASM for the years ended March 31:

 
| ** **                    | ** ** | **Operating Expenses** | ** ** | **Operating Cost Per ASM** | ** ** |
|-------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                    | ** ** | **2005**               | ** ** | **2004**                   | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Wages and benefits            |       | $                      | 6,195      |                       | $          | 6,476 |   | $ | (281 | ) | (4.3 | )% | 10.4 | ¢ | 8.6 | ¢ |
| Aircraft fuel                 |       | 2,471                  |       | 2,282                      |       | 189 |   | 8.3 | % | 4.2 |   | 3.0 |   |
| Aircraft maintenance          |       | 2,416                  |       | 3,319                      |       | (903 | ) | (27.2 | )% | 4.1 |   | 4.4 |   |
| Aircraft rents                |       | 1,976                  |       | 2,449                      |       | (473 | ) | (19.3 | )% | 3.3 |   | 3.3 |   |
| Landing fees                  |       | 249                    |       | 332                        |       | (83 | ) | (25.0 | )% | 0.4 |   | 0.4 |   |
| Insurance and taxes           |       | 510                    |       | 398                        |       | 112 |   | 28.1 | % | 0.9 |   | 0.5 |   |
| Depreciation and amortization |       | 774                    |       | 836                        |       | (62 | ) | (7.4 | )% | 1.3 |   | 1.1 |   |
| Administrative and other      |       | 5,400                  |       | 4,005                      |       | 1,395 |   | 34.8 | % | 9.1 |   | 5.4 |   |
|                          |       | $                      | 19,991     |                       | $          | 20,097 |   | $ | (106 | ) | (0.5 | )% | 33.7 | ¢  | 26.7 | ¢ |

 

Wages and benefits decreased 4.3% primarilydue to a reduction in flying year over year which was partially offset by aworkers’ compensation reserve entry made in fiscal 2005 for outstanding openclaims.  Fiscal 2005 also includedexpenses associated with filling a key vacant position.

 

Aircraft fuel increased 8.3% despite the 19.3% reduction in flying dueto the average cost per gallon of fuel increasing to $1.71 from $1.30.

 

Aircraft maintenance decreased 27.2% to $2.4 million in fiscal 2005from $3.3 million in fiscal 2004 primarily due to reduced flying.  In addition, fiscal 2004 included fuel tankrepairs and engine rental expense associated with the Metro aircraft that didnot continue in fiscal 2005.

 

Aircraft rents decreased due to the return of three Metro aircraftduring fiscal 2005.

 

The increase in insurance and taxes was the result of a property taxadjustment in fiscal 2005.

 

 

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Administrativeand other expenses increased 34.8% in fiscal 2005 over fiscal 2004.  Fiscal 2005 included $1.0 million of costsassociated with non-operating Metro aircraft, and fiscal 2004 included a refundof security fees by the TSA in the amount of $0.2 million.

 

*ConsolidatedOperating Income*

Operating income totaled $8.6 million infiscal 2005, as compared to $4.0 million in fiscal 2004.  The Company’s operating margin increased to1.9% in fiscal 2005 from 0.9% in fiscal 2004.

 

*ConsolidatedNonoperating Income*

Nonoperating income (net) decreased to $2.3million in fiscal 2005 from $4.4 million in fiscal 2004.  The decrease is primarily due to thegovernment grant of $2.6 million in fiscal 2004, which was partially offset byincreased interest income of $0.6 million earned on the Company’s investmentsin fiscal 2005.

 

*ConsolidatedProvision for Income Taxes*

The provision for income taxes decreased 9.1%to $3.6 million in fiscal 2005 from $4.0 million in fiscal 2004.  The company’s blended effective tax rate was32.9% in fiscal 2005 as compared to 46.8% in fiscal 2004.  During the first quarter of fiscal 2005, theCompany received verification of a final settlement with the Internal RevenueService concerning its examination of the Company’s fiscal 1995 and 1996 incometax returns.  As a result of thissettlement, the Company reduced its income tax payable and tax provision by$1.2 million.  Without this adjustment,the Company’s effective tax rate would have been 43.8% in fiscal 2005.  The Company adjusts its effective tax ratequarterly based on forecasted operating results in the fiscal year.  The rate is affected principally by the levelof nondeductible expenses relative to projected taxable income.

 

**Liquidityand Capital Resources**

 

Unrestricted cash, cash equivalents andinvestments decreased $60.1 million, or 35.2%, to $110.7 million at March 31,2006 from $170.8 million at March 31, 2005, primarily due to the capitalcontribution that Holdings made to Mesaba in connection with the ASA and a$12.5 million decrease resulting from the deconsolidation of Mesaba on October13, 2005, the date of Mesaba’s bankruptcy filing.  The Company’s working capital decreased to$85.9 million at March 31, 2006 compared to working capital of $105.3 millionat March 31, 2005.

 

Approximately $25.7 million, or 79.2%, ofMesaba’s accounts receivable balance as of March 31, 2006 consisted of $7.3million in prepetition receivables which can be offset by prepetitionliabilities and $18.4 million in postpetition amounts due from Northwest.  As of June 15, 2006, Mesaba had collected$16.9 million of this March 31, 2006 postpetition balance from Northwest.  Although, Northwest has been payingpostpetition receivables due to Mesaba in the ordinary course of business sinceits bankruptcy, Mesaba’s business is sensitive to events and risks affectingNorthwest.  See previous bankruptcydiscussions and risks related to Northwest and Northwest’s bankruptcy in “Item1.  Business” and “Item 1A. Risk Factors.”  Mesaba’s future liquidity will depend on thereorganization plan it adopts, among other items.

 

*CashFlows*

BigSky

Cash flows (used in) provided by activitiesat Big Sky were $(4.0) million for operating activities, $(0.2) million forinvesting activities and $4.2 million from financing activities.

 

A summary of cash flow activity at Holdingsand Mesaba is presented below.  To allowfor an accurate comparison, Mesaba’s results of operations have been analyzedfor the entire fiscal year ended March 31, 

 

 

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2006 excluding the deconsolidation of Mesabafrom the Company’s consolidated financial statements as of October 13, 2005,the date of Mesaba’s bankruptcy filing. Mesaba’s condensed financial statements on a stand-alone basis arepresented in Note 20 of the accompanying Notes to Consolidated FinancialStatements.

 

*OperatingActivities*

Consolidated

Net cash used in operating activities infiscal 2006 was $21.5 million, primarily due to a net loss of $82.8 million,which was partially offset by impairment and other charges of $50.2 million anddepreciation and amortization of $8.1 million.

 

Mesaba

Net cash used in operating activities infiscal 2006 was $10.0 million, including net cash used in reorganizationactivities of $7.0 million.  Operatingactivities were impacted by a $70.7 million net loss, an increase in accountspayable and other of $47.2 million, depreciation and amortization of $12.2million and a reduction in deferred income taxes of $11.2 million.

 

*Reorganization Activities*

Mesaba

Net cash used in reorganization activities infiscal 2006 was $7.0 million, primarily due to legal and professional feesincurred in the bankruptcy and reorganization of Mesaba.

 

*InvestingActivities*

Consolidated

Net cash provided by investing activities infiscal 2006 was $10.4 million.  Thesource of cash from investing activities was the net sales of short- andlong-term investments of $35.9 million. The uses of cash were $7.1 million for the funding of an irrevocable taxtrust that Mesaba formed as a part of its bankruptcy planning and purchases,primarily of Mesaba property and equipment, of $6.5 million (prior to Mesaba’sdeconsolidation on October 13, 2005). The Company recorded a $12.5 million decrease in cash and cashequivalents from the deconsolidation of Mesaba as of October 13, 2005, the dateof Mesaba’s Chapter 11 bankruptcy filing.

 

Mesaba

Net cash used in investing activities infiscal 2006 was $11.9 million.  Thesource of cash from investing activities was the net sales of investments of$3.0 million.  The uses of cash were the$6.8 million for the funding of an irrevocable tax trust that Mesaba formed asa part of its bankruptcy planning and purchases of property and equipment of$8.1 million.

 

*FinancingActivities*

Consolidated

Net cash used in financing activities infiscal 2006 was not significant.

 

Mesaba

Net cash provided by financing activities infiscal 2006 was $22.2 million which was due to the $31.7 million capitalcontribution made by Holdings in September 2005 in connection with the ASA andpursuant to Holdings’ separate agreement with Northwest.  Of the $31.7 million total investment made byHoldings, $22.2 million was paid in cash and $9.5 million was paid through thetransfer of certain short-term and long-term investments from Holdings.

 

 

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*Outlook*

Consolidated

The Company has historically relied on cashand cash equivalents, investments and internally generated funds (primarilyfrom Mesaba’s operations prior to Mesaba’s bankruptcy and deconsolidation inOctober 2005) to support its working capital requirements.  Absent adverse factors outside the control ofthe Company, management believes current liquidity and funds from Holdings’ andBig Sky’s operations will provide adequate resources for meeting currentobligations through the end of fiscal 2007.

 

Mesaba

As Mesaba downsizes its fleet to a Saab-onlyoperation, its bankruptcy restructuring plan will require significantreductions in labor and non-labor expenses. Simultaneously, Mesaba is actively seeking debtor-in-possessionfinancing, but there can be no assurance that Mesaba will be able to obtainsuch financing.  If Mesaba is unable toobtain debtor-in-possession financing or otherwise generate sufficient cash bythe end of the second quarter of fiscal 2007, Mesaba could be forced intoliquidation.

 

**ContractualObligations, Commitments and Off-Balance Sheet Arrangements**

 

*Mesaba*

Mesaba leases its Saab aircraft, eitherdirectly from aircraft leasing companies or through subleases with Northwestunder operating leases with initial terms of up to 17 years.  Mesaba leases its Avro aircraft fromNorthwest under operating leases with initial terms of up to ten years.  Mesaba subleases its CRJ aircraft fromNorthwest under operating leases with initial terms of ten years.  Mesaba believes that its revenues from theASA will continue to be sufficient to fund its aircraft lease obligations.  If the ASA terminates, then the Saab, Avroand CRJ aircraft leases will simultaneously terminate.

 

Additionally, because Northwest and Mesabahave both filed for bankruptcy protection, both Northwest’s and Mesaba’saircraft-related lease obligations are impacted by Section 1110 of theBankruptcy Code.  If Northwest, in itsbankruptcy, rejects certain leases for aircraft operated by Mesaba or altersthe fleet to be operated by Mesaba, Mesaba could reject the leases related tosuch aircraft in its own Chapter 11 case. As of March 31, 2006, Mesaba had rejected the leases for 11 Saabs leasedfrom Pinnacle.  In June 2006, Mesabafiled with the Bankruptcy Court a motion to reject an additional 12 Avros.  As aircraft are removed from Mesaba’s fleetand leases are terminated, Mesaba will adjust its maintenance accruals for anyreturn conditions, write off any capitalized aircraft modifications that arereturned with the aircraft and record any estimated damage claim from therejected leases as a liability subject to compromise.

 

Mesaba’s airline fleet operating leases donot contain any guaranteed lease residual provisions for which there would be apotential contingency at the termination of the lease period.  The following table summarizes Mesaba’scommitments to make lease payments for the years ending March 31, in thousands:

 
| ** **            | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Operating leases: (1) |       |     |       |     |       |     |       |     |       |     |       |           |       |      |       |
| Aircraft (2)          |       | $        | 49,826     |     | $          | 34,503   |       | $        | 34,503     |     | $          | 34,503         |       | $         | 34,503     |   | $ | 139,975 |   | $ | 327,813 |   |
| Non-aircraft          |       | 4,184    |       | 3,545    |       | 3,570    |       | 3,453    |       | 3,332    |       | 25,038         |       | 43,122    |       |
| Total                 |       | $        | 54,010     |     | $          | 38,048   |       | $        | 38,073     |     | $          | 37,956         |       | $         | 37,835     |   | $ | 165,013 |   | $ | 370,935 |   |

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(1)          Amountsrepresent minimum lease payments with initial or remaining terms of more thanone year.  See “Item 8.  Financial Statements and Supplemental Data,Note 8 — Leases” for additional discussion of operating leases.

 

(2)          Amounts arebased on lease terms, which have early terminations and extensions.  The Saab leases have initial terms of up to17 years with early terminations.  Whilethe leases for 35 Avros had initial terms of up to ten years with extensions,with aggregate monthly lease payments of approximately $5.3 million, the abovelease obligation amounts:

 

a)              Exclude amountsassociated with the 12 Avros idled and removed from the fleet by Northwestduring fiscal 2006; and

b)             Exclude amounts(except for $14.6 million in fiscal 2007) associated with the remaining 23Avros that Northwest has informed the Company will be idled and removed fromthe fleet by December 31, 2006.

 

 

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Shortlyafter Northwest filed for bankruptcy, it unilaterally, and in breach of theASA, removed 12 Avros from Mesaba’s flight schedule.  Mesaba and Northwest then entered into awritten agreement under which Northwest acknowledged that Mesaba was notrequired to make sublease payments on the idled aircraft.  That agreement expired in February 2006.  Mesaba chose to wait to reject the subleasesuntil it was confident that Northwest would not return the idled aircraft tothe flight schedule.  In May 2006, Northwestformally rejected the leases related to the 12 idled Avros.  To ensure that Northwest’s actions haverelieved Mesaba of all liability or obligations arising under the subleases, onJune 13, 2006, Mesaba filed a motion with the Bankruptcy Court to seek formalapproval of Mesaba’s rejection of the 12 idled aircraft.  Mesaba believes that under Section 503(b)(1)of the Bankruptcy Code, which governs administrative claims, Northwest wouldhave no standing to assert an administrative claim against Mesaba for theaircraft rent because Northwest had previously agreed that Mesaba had noobligation to pay rent for grounded aircraft and because Mesaba parked andprotected the aircraft at Northwest’s request.

 

*Big Sky*

As of March 31, 2006, Big Sky’s fleetconsisted of 14 aircraft (ten active and four inactive) covered under operatingleases with terms of 17 to 56 months and aggregate monthly lease payments ofapproximately $0.2 million.  Big Skyleases its aircraft from AirLift Inc. and from Mesa.  Funding of the monthly minimum lease paymentsis dependent on continued passenger boardings, Big Sky’s operations and,potentially, funding from Holdings.

 

Big Sky’s airline fleet operating leases donot contain any guaranteed lease residual provisions for which there would be apotential contingency at the termination of the lease period.  The following table summarizes Big Sky’scommitments to make long-term debt and lease payments for the years endingMarch 31, in thousands:

 
| ** **            | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Operating leases: (1) |       |     |       |     |       |     |       |     |       |     |       |           |       |      |       |
| Aircraft (2)          |       | $        | 1,810      |     | $          | 1,810    |       | $        | 1,810      |     | $          | 1,719          |       | $         | 392        |   | $ | — |   | $ | 7,541 |   |
| Non-aircraft          |       | 123      |       | 37       |       | 17       |       | 17       |       | 17       |       | 234            |       | 445       |       |
| Long-term debt (3)    |       | 149      |       | 55       |       | 40       |       | 43       |       | 47       |       | 222            |       | 556       |       |
| Capital lease (4)     |       | 68       |       | 68       |       | 68       |       | 68       |       | 68       |       | 261            |       | 601       |       |
| Total                 |       | $        | 2,150      |     | $          | 1,970    |       | $        | 1,935      |     | $          | 1,847          |       | $         | 524        |   | $ | 717 |   | $ | 9,143 |   |

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(1)          Amountsrepresent minimum lease payments with initial or remaining terms of more thanone year.  See “Item 8.  Financial Statements and Supplemental Data,Note 8 — Leases” for additional discussion of operating leases on non-idledaircraft.

 

(2)          Amounts arebased on lease terms, which have early terminations and extensions.  The Beechcraft 1900D leases have initialterms of up to five years with early terminations.

 

(3)          Amountsrepresent principal payments only.  See “Item8. Financial Statements and Supplemental Data, Note 9 — Notes Payable andLong-Term Debt” for additional discussion of long-term debt and futurematurities.

 

(4)          See “Item 8.Financial Statements and Supplemental Data, Note 8 — Leases” for additionaldiscussion of the capital lease.

 

 

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*Holdings*

In connection with Holdings’ guaranty ofMesaba’s obligations related to its facility at the Cincinnati/NorthernKentucky International Airport, Holdings is obligated under the facilities andground leases for such facility.  Thefollowing table summarizes Holdings’ guarantee to make lease payments for theyears ending March 31, in thousands:

 
| ** **       | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Operating leases |       | 1,305    |       | 1,306    |       | 1,310    |       | 1,348    |       | 1,306    |       | 23,169         |       | 29,744    |       |
| Total            |       | $        | 1,305      |     | $          | 1,306    |       | $        | 1,310      |     | $          | 1,348          |       | $         | 1,306      |   | $ | 23,169 |   | $ | 29,744 |   |
|                  |            |          |            |          |            |          |            |          |            |          |            |                |            |           |            |  |  |  |  |  |  |  |

 

An off-balance sheet arrangement is anytransaction, agreement or other contractual arrangement involving anunconsolidated entity under which a company has (i) guarantees; (ii) a retainedor a contingent interest in transferred assets; (iii) an obligation underderivative instruments classified as equity; or (iv) any obligation arising outof a material variable interest in an unconsolidated entity that providesfinancing, liquidity, market risk or credit risk support to the company, orthat engages in leasing, hedging, or research and development arrangements withthe company.  Other than Holdings’guaranty related to Mesaba’s facility at the Cincinnati/Northern KentuckyInternational Airport, which is discussed further in “Item 8. FinancialStatements and Supplemental Data, Note 19 — Subsequent Events,” the Company hasno arrangements of the types described that may have a material current orfuture effect on the Company’s financial condition, liquidity or results ofoperations.

 

In connection with Big Sky’s leasing of theBeechcraft aircraft, in April 2005, Holdings entered into a letter of creditagreement with Wells Fargo Bank, N.A.  The letter of credit is in theamount of $1.9 million and is for the benefit of Mesa, who may draw on theletter of credit if Big Sky fails to perform its obligations under theBeechcraft aircraft leases.  The letter of credit automatically renewseach year unless Holdings notifies Mesa that it does not intend to renewit.  If Holdings does not renew the letter of credit, Big Sky’s leaseswith Mesa will increase by approximately $0.5 million per year.

 

**CriticalAccounting Policies and Estimates**

 

The preparation of the Company’s consolidatedfinancial statements and Mesaba’s stand-alone condensed financial statements inconformity with generally accepted accounting principles requires the use ofestimates, judgments and assumptions that affect the reported amounts of assetsand liabilities as of the date of the consolidated financial statements,revenues and expenses during the reporting period and related disclosures ofcontingent assets and liabilities in the consolidated financial statements andthe accompanying notes.  The SEC hasdefined a company’s most critical accounting policies as the ones that are mostimportant to the portrayal of the company’s financial condition and results,and which require the company to make its most difficult and subjectivejudgments, often as a result of the need to make estimates of matters that areinherently uncertain.  Based on thisdefinition, the Company and its subsidiaries have identified their criticalaccounting policies to include those discussed in the following 

 

 

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paragraphs. The Company and its subsidiaries also have other key accounting policiesthat involve the use of estimates, judgments and assumptions.

 

Mesaba’s condensed financial statements havebeen prepared in accordance with Statement of Position 90-7, *Financial Reporting by Entities in Reorganization Under the BankruptcyCode* (“SOP 90-7”), and on a going concern basis, which contemplatescontinuity of operations, realization of assets and liquidation ofpost-petition liabilities in the ordinary course of business.  In accordance with SOP 90-7, the financialstatements for the periods presented distinguish transactions and events thatare directly associated with the reorganization from the ongoing operations ofthe Company.  While operating as adebtor-in-possession under the protection of Chapter 11 of the Bankruptcy Codeand subject to the approval of the Bankruptcy Court or otherwise as permittedin the ordinary course of business, in some cases, Mesaba may sell or otherwisedispose of assets, or liquidate and settle liabilities, for amounts other thanthose reflected in the condensed financial statements.  Further, a plan of reorganization couldmaterially change the amounts and classifications in the historical financialstatements.

 

Management believes that its estimates andassumptions are reasonable, based on information presently available; however,changes in these estimates, judgments and assumptions will occur as a result offuture events, and, accordingly, ultimate results could differ from amountsestimated.

 

*Allowancefor Doubtful Accounts*

Mesaba and Big Sky grant trade credit tocertain approved customers and perform monthly analyses of outstanding tradereceivables to assess the likelihood of collection.  For balances where Mesaba and Big Sky do notexpect full payment of amounts owed, an allowance is recorded to adjust thetrade receivable to management’s best estimate of the amount that willultimately be collected.

 

As discussed in “Item 8. Financial Statementsand Supplemental Data, Note 3 — Northwest and Mesaba Bankruptcy Filings,” thereis a significant amount of uncertainty surrounding the Northwest and Mesababankruptcy processes, which may include negotiations with Northwest regardingMesaba’s ASA.  As such, it is reasonablylikely that the prepetition amounts Mesaba ultimately collects will bedifferent, potentially by a material amount, than Mesaba’s currentestimate.  In future periods, Mesaba willappropriately revise its estimate of recoverable amounts as it becomes aware ofnew information.

 

*Aircraft Property and Equipment* — Estimatedlives are used to record depreciation on aircraft property and equipment.  Aircraft utilization, technology and changes inbusiness strategy may affect the economic lives used to record depreciation byMesaba or Big Sky.  The foregoing mayalso affect depreciation rates, impairment or both.  Management of Mesaba and Big Sky regularlyreview the estimated useful lives and salvage values for aircraft property andequipment.

 

As discussed in “Item 8. Financial Statementsand Supplemental Data, Note 3 — Northwest and Mesaba Bankruptcy Filings,” thereis a significant amount of uncertainty surrounding Northwest’s fleet plan.  As such, it is reasonably likely that iffuture changes to its fleet occur, Mesaba will assess and may need to adjustthe estimated lives on the aircraft that are to be returned and acceleratedepreciation or incur impairment charges accordingly.  In future periods, Mesaba will appropriatelyrevise its estimates as it becomes aware of new information.

 

*Excess and Obsolete Inventories* — Estimatedrecovery percentages are used to record obsolescence reserves for partsinventories.  Aircraft utilization, partsavailability and changes in parts cost may affect the valuation of partsinventories and obsolescence reserve levels. Management of Mesaba and Big Sky regularly review recovery percentages,reserve levels and inventory valuations for parts inventories.

 

 

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As discussed in “Item 8. Financial Statementsand Supplemental Data, Note 3 — Northwest and Mesaba Bankruptcy Filings,”Northwest intends to reduce Mesaba’s Saab fleet and eliminate the Avro fleet byDecember 31, 2006.  As such future eventsoccur, it is likely that Mesaba may incur additional excess inventoryreserves.  In future periods, Mesaba willappropriately revise its estimates as it becomes aware of new information.

 

*Aircraft Maintenance* — Estimatedmaintenance costs and anticipated aircraft activity are used to determinemaintenance reserves.  Changes inmaintenance contracts, parts and labor costs and aircraft activity may affectthe maintenance reserves.  Management ofMesaba and Big Sky regularly review aircraft activity, expected aircraft returndates, changes in maintenance contracts and parts and labor costs formaintenance reserves.

 

As discussed in “Item 8. Financial Statementsand Supplemental Data, Note 3 — Northwest and Mesaba Bankruptcy Filings,” thereis a significant amount of uncertainty surrounding Northwest’s fleet plan.  As a general rule, Mesaba alters maintenanceaccruals on aircraft that are to be returned and reverses previouslyestablished reserves once the aircraft are no longer in service.  Due toNorthwest’s and Mesaba’s bankruptcy proceedings, Mesaba will not reversemaintenance accruals or write off reserves until such time as either Northwest’sor Mesaba’s bankruptcy court has formally approved the rejection ofaircraft.  Therefore, in future periods, Mesaba will appropriately reviseits maintenance estimates as it becomes aware of new information.

 

*Goodwill and Other IntangibleAssets* — The excess of the Big Sky purchase price over the fair market valueof the net assets acquired was allocated to certain identifiable intangibleassets, including Big Sky’s pilot labor contract, its air carrier certificateand goodwill.  The recoverability ofgoodwill and other intangible assets is evaluated annually, at a minimum, or onan interim basis if events or circumstances indicate a possible inability torealize the carrying amounts.  Theevaluation includes future cash flow projections, strategic modeling and othermanagement assumptions.  During thesecond quarter of fiscal 2006, the Company completed an interim impairment testof goodwill and other intangible assets. Based on the results of the test, the Company recorded an impairmentcharge of approximately $2.5 million to write off the entire amount ofgoodwill.  The impairment amount wasdetermined by comparing the fair value of the intangible assets to the currentcarrying value.  Fair value was derivedusing a discounted cash flow analysis. Because the fair value was less than the carrying value of the assets,the Company recorded an impairment charge to reduce the carrying value of theassets to estimated fair value.

 

*Income Taxes* — The Company’seffective tax rate was (24.4%), 32.9% and 46.8% in fiscal 2006, 2005 and 2004,respectively.  In fiscal 2006, theCompany recorded a valuation allowance against its net deferred tax assets inthe amount of $3.6 million.  The Company’seffective tax rate is based on expected income, statutory tax rates and taxplanning opportunities available in the various jurisdictions in which the Companyoperates.  In the event that there is asignificant unusual or one-time item recognized, or expected to be recognized,in the Company’s operating results, the tax attributable to that item would beseparately calculated and recorded at the same time as the unusual or one-timeitem.  Significant judgment is requiredin determining the Company’s effective tax rate and in evaluating its taxpositions.  The Company establishesreserves when, despite its belief that the tax return positions are fullysupportable, certain positions are likely to be challenged and may notsucceed.  The Company adjusts thesereserves in light of changing facts and circumstances, such as the closing of atax audit.  The effective tax rateincludes the impact of reserve provisions and changes to reserves that areconsidered appropriate, as well as related interest.  This rate is then applied to the Company’squarterly operating results.

 

Significant management judgment is requiredin determining the provisions for income taxes, deferred tax assets andliabilities and any valuation allowance recorded against net deferred taxassets.  For financial 

 

 

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reporting purposes, a valuation allowance isrecorded to offset deferred tax assets that, more likely than not, will not berealized based on the Company’s projected future taxable income, the timing ofexpiring net operating losses and the Company’s tax planning strategies.  In the future, subsequent revisions to theestimated net realizable value of these deferred tax assets could cause theCompany to record a valuation allowance on all or a portion of the deferred taxassets.  This could cause the provisionfor income taxes to vary significantly from period to period, although the Company’scash payments would remain unaffected until the benefit of the net operatinglosses is completely utilized or expires unused.

 

*Workers’ Compensation Insurance* — Mesaba andBig Sky estimate the ultimate cost of an on-the-job injury at the time of theinjury to determine their workers’ compensation insurance reserves.  Mesaba and Big Sky use the services of theirrespective insurance carriers and outside brokers to assist in determining thereserve levels.  Injury severity, cost ofcare and the insurance contract affect the ultimate cost and ultimate reservesrecorded.  Management of Mesaba and BigSky regularly review workers’ compensation activity with outside consultantsfor any changes in the workers’ compensation reserve.

 

*Health and Dental Insurance* — Mesabaestimates the amount of incurred but not reported health and dental claims todetermine its health and dental insurance reserves.  Mesaba uses the service of its insurancecarriers and outside brokers to assist in determining the reserve levels.  Historical claims experience, claims severityand cost of care affect the ultimate cost and ultimate reserves recorded.  Management of Mesaba regularly reviews healthand dental claims activity with outside consultants for any changes in thehealth and dental insurance reserve. Holdings and Big Sky purchase health and dental insurance and,therefore, do not make estimates for health and dental claims.

 

*Property Taxes* — Estimatedproperty tax values and assessments are used to record property tax reservesfor the various jurisdictions in which Mesaba and Big Sky operate.  Aircraft and parts values, aircraft flightactivity, ground equipment values and the location of personnel may affect theultimate property tax obligation. Management of Mesaba and Big Sky periodically review the above items forany changes in the property tax reserves.

 

**NewAccounting Pronouncements**

 

In May 2005, the Financial AccountingStandards Board (“FASB”) issued Statement of Accounting Standards (“SFAS”) No.154,*Accounting Changes and ErrorCorrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3*.  SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements for changes in accountingprinciples, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. SFAS No. 154 also requires thatretrospective application of a change in accounting principle be limited to thedirect effects of the change.  Indirecteffects of a change in accounting principle, such as a change innon-discretionary profit-sharing payments resulting from an accounting change,should be recognized in the period of the accounting change.  SFAS No. 154 also provides that a change indepreciation, amortization, or depletion method for long-lived, non-financialassets be accounted for as a change in accounting estimate effected by a changein accounting principle.  SFAS No. 154carries forward without change the guidance contained in APB Opinion No. 20 forreporting the correction of an error in previously issued financial statementsand a change in accounting estimate and the guidance in APB Opinion No. 20requiring justification of a change in accounting principle on the basis ofpreferability.  SFAS No. 154 will be effective for the Company on April 1,2006.

 

In December 2004, the FASB issued SFAS No.123(R),*Share-Based Payment*,which is a revision of SFAS No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25 and amends SFAS No. 95,*Statement of Cash Flows*.  The revision requires companies to measureand recognize compensation expense for all share-based payments to employees,including grants of employee stock options, in the financial 

 

 

44

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statements based on the fair value at thedate of the grant.  SFAS No. 123(R)permits companies to adopt its requirements using either the modifiedprospective method or the modified retrospective method.  Under the modified prospective method,compensation cost is recognized beginning with the effective date for allshare-based payments granted after the effective date and for all awardsgranted to employees prior to the effective date of SFAS No. 123(R) that remainunvested on the effective date.  Themodified retrospective method includes the requirements of the modifiedprospective method, but also permits entities to restate either all priorperiods presented or prior interim periods of the year of adoption for theimpact of adopting this standard.  TheCompany will apply the modified prospective method upon adoption. In April2005, the Securities and Exchange Commission announced it would provide forphased-in implementation of SFAS No. 123(R). As a result, SFAS No. 123(R) is effective for the first interim orannual reporting period of the registrant’s first fiscal year beginning on orafter June 15, 2005.  The Companyprojects that compensation expense related to employee stock options issued asof March 31, 2006 will be approximately $0.3 million in fiscal 2007.   SFAS No. 123(R) also requires the benefitsof tax deductions in excess of recognized compensation costs to be reported asfinancing cash flow, rather than as an operating cash flow as required undercurrent literature.  This requirementwill reduce net operating cash flows and increase net financing cash flows inperiods after adoption.  Managementbelieves that this reclassification will not have a material impact on theCompany’s consolidated statements of cash flows.

## ***Item7A.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK***

 

The Company’s principal market risks are theavailability and price of jet fuel and changes in interest rates, as discussedbelow.

 

*AircraftFuel*

The Company believes that Mesaba’sarrangements for fuel with Northwest assure an adequate supply of fuel forcurrent and future operations, provided that Northwest does not experience asupply shortage.  As a part of the ASA,Northwest bears the economic risk of fuel price fluctuations for Mesaba’s Saaband CRJ fuel requirements, as the fuel price for Mesaba’s Saabs is fixed at83.5¢ per gallon, and the fuel for Mesaba’s CRJs is fixed at 70¢ pergallon.  The ASA also requires Northwestto provide all fuel at its expense to support Mesaba’s Avro operations.  Big Sky is subject to fluctuations in fuelprices.  A hypothetical 10% increase inthe March 31, 2006 cost per gallon of fuel, assuming projected fiscal 2007usage at Big Sky, would result in an increase to aircraft fuel expense ofapproximately $0.6 million in fiscal 2007. As of March 31, 2006, Big Sky had no fuel hedges in place for fiscal2007.

 

*InterestRates*

The Company’s earnings are affected bychanges in interest rates due to the impact those changes have on its interestincome from cash equivalents and short and long-term investments.  If interest rates were to increase by 100basis points for a full year, based on the Company’s cash equivalents,short-term and long-term investments balance at March 31, 2006, the Company’sinterest income from cash equivalents, short-term and long-term investmentswould increase by approximately $1.1 million.

 

The Company does not purchase or hold anyderivative financial instruments for trading or speculative purposes.

 

 

45

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## ***Item8.  FINANCIAL STATEMENTS AND SUPPLEMENTALDATA***

 

Theconsolidated financial statements of the Company and the related reports ofmanagement and the Company’s independent registered public accounting firm areincluded in this Annual Report on Form 10-K on the pages indicated below.

 
| Report of Independent Registered Public Accounting  Firm                                                             | 47 |
|----------------------------------------------------------------------------------------------------------------------|----|
| Consolidated Balance Sheets as of March 31, 2006  and 2005                                                           | 48 |
| Consolidated Statements of Operations for the  Years Ended March 31, 2006, 2005 (As Restated) and 2004 (As Restated) | 49 |
| Consolidated Statements of Shareholders’ Equity for the Years Ended  March 31, 2006, 2005 and 2004              | 50 |
| Consolidated Statements of Cash Flows for the Years Ended March 31,  2006, 2005 and 2004                             | 51 |
| Notes to the Consolidated Financial Statements                                                                       | 52 |

 

 

46

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

Tothe Board of Directors and Shareholders

MAIRHoldings, Inc.

Minneapolis, Minnesota

 

We have audited the accompanying consolidatedbalance sheets of MAIR Holdings, Inc. and subsidiaries (the “Company”) as ofMarch 31, 2006 and 2005, and the related consolidated statements of operations,shareholders’ equity, and cash flows for each of the three years in the periodended March 31, 2006.  These financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these financial statements based on our audits.

 

We conducted our audits in accordance withthe standards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financialstatements.  An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.  We believe that our audits provide areasonable basis for our opinion.

 

In our opinion, such consolidated financialstatements present fairly, in all material respects, the financial position ofthe Company as of March 31, 2006 and 2005, and the results of its operationsand its cash flows for each of the three years in the period ended March 31,2006 in conformity with accounting principles generally accepted in the UnitedStates of America.

 

As discussed in Notes 1 and 3, MesabaAviation, Inc. (Debtor-in-Possession) (“Mesaba”), a wholly-owned subsidiary ofthe Company, filed for reorganization under Chapter 11 of the United StatesBankruptcy Code on October 13, 2005, at which time the financial condition andresults of operations of Mesaba were deconsolidated from the Company’sconsolidated financial statements and presented under the equity method ofaccounting.  The condensed financial statements of Mesaba presented inNote 20 do not purport to reflect or provide for the consequences of bankruptcyproceedings. In particular, such financial statements do not purport to show(a) as to assets, their realizable value on a liquidation basis or theiravailability to satisfy liabilities; (b) as to prepetition liabilities, allamounts that may be allowed for claims or contingencies, or the status andpriority thereof; (c) as to stockholder accounts, the effect of any changesthat may be made in the capitalization of the Company; or (d) as to operations,the effect of any changes that may be made in its business.

 

As discussed in Note 16, the accompanyingconsolidated statements of operations for the years ended March 31, 2005 and2004 have been restated.

 

We have also audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theeffectiveness of the Company’s internal control over financial reporting as ofMarch 31, 2006, based on the criteria established in *InternalControl — Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission and our report dated June 22, 2006,expressed an unqualified opinion on management’s assessment of theeffectiveness of the Company’s internal control over financial reporting and anunqualified opinion on the effectiveness of the Company’s internal control overfinancial reporting.

 

DELOITTE & TOUCHE LLP

 

Minneapolis, Minnesota

June 22, 2006

 

 

47

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**MAIRHOLDINGS, INC. AND SUBSIDIARIES**

**ConsolidatedBalance Sheets**

**As ofMarch 31, 2006 and 2005**

**(inthousands, except per share information)**

 
| ** **                                                                                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| ASSETS                                                                                                               |       |     |       |     |       |
| CURRENT ASSETS:                                                                                                      |       |     |       |     |       |
| Cash and cash equivalents                                                                                            |       | $        | 47,135     |     | $          | 57,968 |   |
| Short-term investments                                                                                               |       | 44,117   |       | 69,669   |       |
| Accounts receivable, net of reserves of $33 and $601                                                                 |       | 3,984    |       | 31,176   |       |
| Inventories, net                                                                                                     |       | 589      |       | 11,034   |       |
| Prepaid expenses and deposits                                                                                        |       | 2,611    |       | 5,808    |       |
| Deferred income taxes and other                                                                                      |       | —   |       | 11,892   |       |
| Total current assets                                                                                                 |       | 98,436   |       | 187,547  |       |
| PROPERTY AND EQUIPMENT, net (Note 2)                                                                                 |       | 1,423    |       | 38,421   |       |
| NONCURRENT ASSETS:                                                                                                   |       |     |       |     |       |
| Long-term investments                                                                                                |       | 19,484   |       | 43,240   |       |
| Goodwill                                                                                                             |       | —   |       | 2,503    |       |
| Other intangible assets, net                                                                                         |       | 2,413    |       | 2,819    |       |
| Other assets, net                                                                                                    |       | 186      |       | 6,424    |       |
|                                                                                                                 |       | $        | 121,942    |     | $          | 280,954 |   |
| LIABILITIES AND  SHAREHOLDERS’ EQUITY                                                                           |       |     |       |     |       |
| CURRENT LIABILITIES:                                                                                                 |       |     |       |     |       |
| Accounts payable                                                                                                     |       | $        | 2,745      |     | $          | 19,151 |   |
| Accrued liabilities:                                                                                                 |       |     |       |     |       |
| Payroll                                                                                                              |       | 1,421    |       | 19,563   |       |
| Maintenance                                                                                                          |       | 3        |       | 20,281   |       |
| Deferred income                                                                                                      |       | 716      |       | 3,085    |       |
| Other current liabilities                                                                                            |       | 7,686    |       | 20,126   |       |
| Total current liabilities                                                                                            |       | 12,571   |       | 82,206   |       |
|                                                                                                                 |       |     |       |     |       |
| OTHER NONCURRENT LIABILITIES                                                                                         |       | 772      |       | 6,069    |       |
|                                                                                                                 |       |     |       |     |       |
| COMMITMENTS AND CONTINGENCIES (Notes 8,9 and 14)                                                                     |       |     |       |     |       |
|                                                                                                                 |       |     |       |     |       |
| SHAREHOLDERS’ EQUITY:                                                                                           |       |     |       |     |       |
| Undesignated preferred stock, no specified par value; 1,000,000  shares authorized, no shares issued and outstanding |       | —   |       | —   |       |
| Common stock, $.01 par value; 60,000,000 shares authorized,  20,591,840 and 20,574,340 shares issued and outstanding |       | 206      |       | 206      |       |
| Paid-in capital                                                                                                      |       | 69,546   |       | 70,856   |       |
| Accumulated other comprehensive (loss) income                                                                        |       | (176     | )          | (254     | )          |
| Retained earnings                                                                                                    |       | 39,023   |       | 121,871  |       |
| Total shareholders’ equity                                                                                      |       | 108,599  |       | 192,679  |       |
|                                                                                                                 |       | $        | 121,942    |     | $          | 280,954 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

 

48

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**MAIRHOLDINGS, INC. AND SUBSIDIARIES**

**ConsolidatedStatements of Operations**

**YearsEnded March 31, 2006, 2005 and 2004**

**(inthousands, except share information)**

 
| ** **                                                                                             | ** ** | ** ** | ** ** | **As restated-see Note 16** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|
| ** **                                                                                             | ** ** | **2006**   | ** ** | **2005**                    | ** ** | **2004** | ** ** |
| OPERATING REVENUES:                                                                                    |       |       |       |                        |       |   |   |
| Passenger                                                                                              |       | $          | 228,920    |                        | $          | 400,398 |   | $ | 401,010 |   |
| Freight and other                                                                                      |       | 27,359     |       | 42,212                      |       | 31,779 |   |
| Total operating revenues                                                                               |       | 256,279    |       | 442,610                     |       | 432,789 |   |
| OPERATING EXPENSES:                                                                                    |       |       |       |                        |       |   |   |
| Wages and benefits                                                                                     |       | 88,666     |       | 148,652                     |       | 143,124 |   |
| Aircraft fuel                                                                                          |       | 4,826      |       | 2,471                       |       | 2,282 |   |
| Aircraft maintenance                                                                                   |       | 49,940     |       | 84,276                      |       | 80,700 |   |
| Aircraft rents                                                                                         |       | 56,251     |       | 102,478                     |       | 105,460 |   |
| Landing fees                                                                                           |       | 5,781      |       | 10,208                      |       | 10,935 |   |
| Insurance and taxes                                                                                    |       | 5,368      |       | 7,383                       |       | 9,347 |   |
| Depreciation and amortization                                                                          |       | 8,127      |       | 14,634                      |       | 17,144 |   |
| Administrative and other                                                                               |       | 49,818     |       | 63,869                      |       | 59,771 |   |
| Impairment and other charges                                                                           |       | 50,203     |       | —                      |       | — |   |
| Total operating expenses                                                                               |       | 318,980    |       | 433,971                     |       | 428,763 |   |
| Operating (loss) income                                                                                |       | (62,701    | )          | 8,639                       |       | 4,026 |   |
| NONOPERATING INCOME (EXPENSE):                                                                         |       |       |       |                        |       |   |   |
| Interest income and other                                                                              |       | 6,039      |       | 2,381                       |       | 1,888 |   |
| Government grant income                                                                                |       | —     |       | —                      |       | 2,646 |   |
| Interest expense                                                                                       |       | (75        | )          | (61                         | )          | (101 | ) |
| Other nonoperating income, net                                                                         |       | 5,964      |       | 2,320                       |       | 4,433 |   |
| (Loss) income before benefit (provision) for income taxes and equity  in loss of Mesaba Aviation, Inc. |       | (56,737    | )          | 10,959                      |       | 8,459 |   |
|                                                                                                   |       |       |       |                        |       |   |   |
| BENEFIT (PROVISION) FOR INCOME TAXES                                                                   |       | 13,842     |       | (3,604                      | )          | (3,963 | ) |
| (Loss) income before equity in loss of Mesaba Aviation, Inc.                                           |       | (42,895    | )          | 7,355                       |       | 4,496 |   |
|                                                                                                   |       |       |       |                        |       |   |   |
| EQUITY IN LOSS OF MESABA AVIATION, INC., net of tax                                                    |       | (39,953    | )          | —                      |       | — |   |
|                                                                                                   |       |       |       |                        |       |   |   |
| NET (LOSS) INCOME                                                                                      |       | $          | (82,848    | )                           | $          | 7,355 |   | $ | 4,496 |   |
|                                                                                                   |       |       |       |                        |       |   |   |
| NET (LOSS) INCOME PER SHARE:                                                                           |       |       |       |                        |       |   |   |
| (Loss) earnings per common share - basic                                                               |       | $          | (4.02      | )                           | $          | 0.36 |   | $ | 0.22 |   |
| (Loss) earnings per common share - diluted                                                             |       | $          | (4.02      | )                           | $          | 0.35 |   | $ | 0.22 |   |
|                                                                                                   |       |       |       |                        |       |   |   |
| WEIGHTED AVERAGE SHARES OUTSTANDING:                                                                   |       |       |       |                        |       |   |   |
| Basic                                                                                                  |       | 20,584     |       | 20,505                      |       | 20,334 |   |
| Diluted                                                                                                |       | 20,584     |       | 21,050                      |       | 20,562 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

 

49

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**MAIRHOLDINGS, INC. AND SUBSIDIARIES**

**ConsolidatedStatements of Shareholders’ Equity**

**YearsEnded March 31, 2006, 2005 and 2004**

**(inthousands, except share information)**

 
| ** **                                                                  | ** ** | **Common Stock** | ** ** | **Paid-In  Capital** | ** ** | **Accumulated Other Comprehensive  Income (Loss)** | ** ** | **Retained   Earnings** | ** ** | **Total Shareholders’  Equity** | ** ** | ** ** | **Comprehensive  Income (Loss)** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------|------------|----------------------|------------|----------------------------------------------------|------------|-------------------------|------------|--------------------------------------|------------|------------|----------------------------------|------------|
| **Shares**                                                                  | ** ** | **Amount**       |
| Balance, March 31, 2003                                                     |       | 20,320,641       |       | $                    | 203        |                                               | $          | 67,115                  |       | $                                    | 116        |       | $                                | 110,020    |   | $ | 177,454 |   |   |   |   |
|                                                                        |       |             |       |                 |       |                                               |       |                    |       |                                 |       |       |                             |       |   |   |
| Net income                                                                  |       |             |       |                 |       |                                               |       |                    |       | 4,496                                |       | 4,496      |                             |       | $ | 4,496 |   |
| Exercise of stock options                                                   |       | 54,731           |       | 1                    |       | 355                                                |       |                    |       |                                 |       | 356        |                             |       |   |   |
| Compensation expense for stock options under variable accounting            |       |             |       |                 |       | 1,987                                              |       |                    |       |                                 |       | 1,987      |                             |       |   |   |
| Tax benefit on stock options exercised                                      |       |             |       |                 |       | 38                                                 |       |                    |       |                                 |       | 38         |                             |       |   |   |
| Unrealized loss on investments, net of tax                                  |       |             |       |                 |       |                                               |       | (70                     | )          |                                 |       | (70        | )                                |       | (70 | ) |
| Balance, March 31, 2004                                                     |       | 20,375,372       |       | 204                  |       | 69,495                                             |       | 46                      |       | 114,516                              |       | 184,261    |                             |       | $ | 4,426 |   |
|                                                                        |       |             |       |                 |       |                                               |       |                    |       |                                 |       |       |                             |       |   |   |
| Net income                                                                  |       |             |       |                 |       |                                               |       |                    |       | 7,355                                |       | 7,355      |                             |       | 7,355 |   |
| Exercise of stock options                                                   |       | 198,968          |       | 2                    |       | 1,201                                              |       |                    |       |                                 |       | 1,203      |                             |       |   |   |
|                                                                        |       |             |       |                 |       |                                               |       |                    |       |                                 |       |       |                             |       |   |   |
| Compensation expense (benefit) for stock options under variable  accounting |       |             |       |                 |       | (13                                                | )          |                    |       |                                 |       | (13        | )                                |       |   |   |
| Tax benefit on stock options exercised                                      |       |             |       |                 |       | 173                                                |       |                    |       |                                 |       | 173        |                             |       |   |   |
| Unrealized loss on investments, net of tax                                  |       |             |       |                 |       |                                               |       | (300                    | )          |                                 |       | (300       | )                                |       | (300 | ) |
| Balance, March 31, 2005                                                     |       | 20,574,340       |       | 206                  |       | 70,856                                             |       | (254                    | )          | 121,871                              |       | 192,679    |                             |       | $ | 7,055 |   |
|                                                                        |       |             |       |                 |       |                                               |       |                    |       |                                 |       |       |                             |       |   |   |
| Net loss                                                                    |       |             |       |                 |       |                                               |       |                    |       | (82,848                              | )          | (82,848    | )                                |       | (82,848 | ) |
| Exercise of stock options                                                   |       | 17,500           |       |                 |       | 114                                                |       |                    |       |                                 |       | 114        |                             |       |   |   |
|                                                                        |       |             |       |                 |       |                                               |       |                    |       |                                 |       |       |                             |       |   |   |
| Compensation expense (benefit) for stock options under variable  accounting |       |             |       |                 |       | (1,436                                             | )          |                    |       |                                 |       | (1,436     | )                                |       |   |   |
| Tax benefit on stock options exercised                                      |       |             |       |                 |       | 12                                                 |       |                    |       |                                 |       | 12         |                             |       |   |   |
| Unrealized gain on investments                                              |       |             |       |                 |       |                                               |       | 78                      |       |                                 |       | 78         |                             |       | 78 |   |
| Balance, March 31, 2006                                                     |       | 20,591,840       |       | $                    | 206        |                                               | $          | 69,546                  |       | $                                    | (176       | )          | $                                | 39,023     |   | $ | 108,599 |   |   | $ | (82,770 | ) |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

 

 

50

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**MAIRHOLDINGS, INC. AND SUBSIDIARIES**

**ConsolidatedStatements of Cash Flows**

**YearsEnded March 31, 2006, 2005 and 2004**

**(inthousands)**

 
| ** **                                                                                          | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                               |       |     |       |     |       |     |       |
| Net (loss) income                                                                                   |       | $        | (82,848    | )        | $          | 7,355    |       | $ | 4,496 |   |
| Adjustments to reconcile net (loss) income to net cash (used in)  provided by operating activities: |       |     |       |     |       |     |       |
| Equity in loss of Mesaba Aviation, Inc.                                                             |       | 39,953   |       | —   |       | —   |       |
| Depreciation and amortization                                                                       |       | 8,127    |       | 14,634   |       | 17,144   |       |
| Amortization of deferred credits                                                                    |       | (813     | )          | (1,399   | )          | (1,795   | )          |
| Stock-based compensation                                                                            |       | (1,436   | )          | (13      | )          | 1,987    |       |
| Deferred income taxes                                                                               |       | (10,500  | )          | 426      |       | (1,408   | )          |
| Amortization of investment discounts                                                                |       | 141      |       | 2,081    |       | 1,719    |       |
| Impairment and other charges                                                                        |       | 50,203   |       | —   |       | —   |       |
| Changes in current operating items:                                                                 |       |     |       |     |       |     |       |
| Accounts receivable                                                                                 |       | (36,671  | )          | (1,682   | )          | 11,188   |       |
| Inventories                                                                                         |       | (791     | )          | (2,370   | )          | (205     | )          |
| Prepaid expenses and deposits                                                                       |       | (2,279   | )          | (2,366   | )          | (456     | )          |
| Accounts payable and other                                                                          |       | 15,433   |       | 5,450    |       | 13,250   |       |
| Net cash (used in) provided by operating activities                                                 |       | (21,481  | )          | 22,116   |       | 45,920   |       |
|                                                                                                |       |     |       |     |       |     |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |       |     |       |     |       |     |       |
| Purchases of investments                                                                            |       | (145,613 | )          | (105,702 | )          | (95,775  | )          |
| Sales of investments                                                                                |       | 181,496  |       | 97,482   |       | 59,381   |       |
| Purchases of property and equipment                                                                 |       | (6,482   | )          | (9,659   | )          | (10,717  | )          |
| Sale of property and equipment                                                                      |       | 617      |       | —   |       | —   |       |
| Increase in restricted cash                                                                         |       | (7,100   | )          | —   |       | —   |       |
| Net decrease in cash and cash equivalents from deconsolidation of  Mesaba Aviation, Inc.            |       | (12,479  | )          | —   |       | —   |       |
| Net cash provided by (used in) investing activities                                                 |       | 10,439   |       | (17,879  | )          | (47,111  | )          |
|                                                                                                |       |     |       |     |       |     |       |
| CASH FLOWS FROM FINANCING ACTIVITIES                                                                |       |     |       |     |       |     |       |
| Repayment of other noncurrent liabilities                                                           |       | (150     | )          | (133     | )          | (244     | )          |
| Net borrowings on line of credit                                                                    |       | 245      |       | —   |       | —   |       |
| Proceeds from issuance of common stock                                                              |       | 114      |       | 1,203    |       | 356      |       |
| Net cash provided by financing activities                                                           |       | 209      |       | 1,070    |       | 112      |       |
|                                                                                                |       |     |       |     |       |     |       |
| NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS                                                |       | (10,833  | )          | 5,307    |       | (1,079   | )          |
| CASH AND CASH EQUIVALENTS:                                                                          |       |     |       |     |       |     |       |
| Beginning of year                                                                                   |       | 57,968   |       | 52,661   |       | 53,740   |       |
| End of year                                                                                         |       | $        | 47,135     |     | $          | 57,968   |       | $ | 52,661 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

 

51

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**MAIRHOLDINGS, INC. AND SUBSIDIARIES**

**Notesto Consolidated Financial Statements**

**YearsEnded March 31, 2006, 2005 and 2004**

 

 

**1.****             ****CorporateOrganization and Business**

 

*CorporateOrganization*

The consolidated financial statements includethe accounts of MAIR Holdings, Inc. (“Holdings” or the “Company”) and itswholly-owned subsidiaries, Big Sky Transportation Co. (“Big Sky”), and MesabaAviation, Inc. (“Mesaba”) until its bankruptcy filing on October 13, 2005.  All intercompany transactions and balanceshave been eliminated in consolidation. As discussed below, the accounts of Mesaba have been deconsolidated fromthe Company’s consolidated financial statements effective October 13, 2005.

 

As discussed in Note 3, Mesaba filed avoluntary petition for relief under Chapter 11 of the United States BankruptcyCode (“Bankruptcy Code”) in the United States Bankruptcy Court for the Districtof Minnesota (the “Bankruptcy Court”) on October 13, 2005. Mesaba is operatingits business as a debtor-in-possession pursuant to the Bankruptcy Code.  Mesaba’s financial statements have beenprepared on a going concern basis, which contemplates continuity of operations,realization of assets and liquidation of postpetition liabilities in theordinary course of business.

 

Due to Mesaba’s bankruptcy and theuncertainties surrounding the nature, timing, and specifics of the bankruptcyproceedings, Holdings deconsolidated Mesaba’s financial results under theequity method of accounting effective October 13, 2005.  As a result, Mesaba’s assets and liabilitieshave been removed from the Company’s consolidated balance sheet as of March 31,2006 and replaced with Holdings’ investment in Mesaba (see Note 2 — Investmentin Mesaba).  Mesaba’s results ofoperations have been removed from the Company’s consolidated results ofoperations and cash flows since October 13, 2005, but continue to be includedin such consolidated financial statements for periods prior to October 13,2005.  Because Holdings owns all of thecommon stock of Mesaba, this change did not affect the amount of net lossHoldings reported resulting from Mesaba’s operation in any current or priorperiod, but resulted in Mesaba’s net loss from the date of the bankruptcyforward being presented as “Equity in income (loss) of Mesaba” rather than itsresults being included in each individual statement of operations line item, aswas the case for periods prior to October 13, 2005.

 

Subsequent to the bankruptcy filing date, theprovisions of Statement of Position 90-7, *Financial Reporting byEntities in Reorganization Under the Bankruptcy Code*, (“SOP 90-7”),apply to Mesaba’s financial statements while Mesaba operates under theprovisions of Chapter 11.  SOP 90-7 doesnot change the application of accounting principles generally accepted in theUnited States (“GAAP”) in the preparation of financial statements.  However, SOP 90-7 does require that thefinancial statements, for periods including and subsequent to the filing ofChapter 11 petition, distinguish transaction and events that are directlyassociated with the reorganization from the ongoing operations of thebusiness.  See Note 20 for the condensedfinancial statements of Mesaba presented in accordance with SOP 90-7 on astand-alone basis as of March 31, 2006 and 2005 and its results of operationsand cash flows for each of the three years in the period ended March 31, 2006.

 

*Business*

 

*Mesaba*

Mesaba operates as a regional carrierproviding scheduled passenger service as “Mesaba Airlines/Northwest Airlink”and Mesaba Airlines/Northwest Jet Airlink under a ten-year omnibus AirlineService Agreement (“ASA”) with Northwest Airlines, Inc. (“Northwest”) datedAugust 29, 2005.  Neither 

 

 

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Mesaba nor Northwest has assumed or rejectedthe ASA in their respective bankruptcy proceedings, and both parties arecontinuing to operate under the terms of the ASA (see Note 3 regardingNorthwest filing for Chapter 11 bankruptcy protection on September 14, 2005 andthe effect of such filing on the ASA) Prior to the ASA, Mesaba provided regional airline services to Northwestpursuant to two separate agreements, an Airline Service Agreement (the “AirlinkAgreement”) that governed Mesaba’s operation of Saab 340 jet-prop aircraft (“Saabs”),and a Regional Jet Services Agreement (the “Jet Agreement”) that governedMesaba’s operation of Avro RJ85 regional jets (“Avros”).  The ASA is an omnibus agreement thatincorporates the existing payment terms for the Saabs and the Avros containedin the Airlink Agreement and the Jet Agreement and adds new payment terms forthe Canadair regional jets (“CRJ’s”) that Mesaba began operating in October2005.  As of March 31, 2006, Mesabaserved 102 cities in the United States and Canada from Northwest’s hub airportslocated in Minneapolis/St. Paul, Detroit and Memphis.

 

Northwest purchases Mesaba’s entire capacityand pays Mesaba in arrears on the 11th and 26th of each month for regionalairline services that Mesaba provides to Northwest utilizing the Saabs andAvros.  Beginning in October 2005,Northwest began paying Mesaba, on a regular bi-monthly basis, on the 1st and16th of each month for regional airline services that Mesaba provides toNorthwest utilizing the CRJs.  The CRJpayment made on the 1st of each month represents a prepayment based on anestimate of regional airline services to be provided by Mesaba for the first 15days of the month.  The CRJ payment madeon the 16th of the month consists of a prepayment based on an estimate ofregional airline services to be provided by Mesaba for the 16th through the endof the month and a true-up amount adjusting for actual services provided byMesaba in the prior month.

 

For flights utilizing the Saabs, Mesabarecognizes revenue for each completed available seat mile, or ASM (the numberof seats in an aircraft multiplied by the number of miles those seats areflown), and purchases fuel (which is set at a fixed price of $0.835 pergallon), ground handling and other services from Northwest.  Mesaba paid Northwest $18.3 million, $21.9million and $19.7 million for ground handling and other services in fiscal2006, 2005 and 2004, respectively.

 

For flights utilizing the Avros, Mesabarecognizes revenue for each block hour flown (the elapsed time between aircraftdeparting and arriving at a gate). Northwest provides fuel and airport and passenger related services atNorthwest’s expense for the Avros.

 

For flights utilizing the CRJs, Mesabarecognizes revenue though monthly expense reimbursement payments for actualexpenses incurred relating to aircraft rent, maintenance, landing fees and fuel(which is set at a fixed price of $0.70 per gallon); semi-monthly payments foreach block hour and cycle operated; a monthly fixed cost payment based on thesize of the CRJ fleet (intended to cover Mesaba’s costs that are not reimbursedthrough the monthly reimbursement payments, which consist mainly of laborcosts, ground handling costs, overhead and depreciation) and margin paymentsbased on  the revenues described abovecalculated to achieve a target operating margin.  The targeted operating margin through April2007 is set at a fixed amount, after which time the target operating marginwill be based on the average operating margin of the publicly traded UnitedStates domestic regional airline operating primarily regional jet aircraft,excluding Pinnacle Airlines Corp. (“Pinnacle”), and any regional carrier underbankruptcy protection, subject to a margin cap and floor.

 

The ASA contains termination provisions thatallow both Mesaba and Northwest to terminate the ASA in the event the otherparty breaches the agreement, subject to the other party’s right to cure thebreach within a prescribed time period. Additionally, Northwest may terminate the ASA in the event of certainlease and other performance defaults by Mesaba; failure by Mesaba to maintainrequired insurance coverage; failure by Mesaba to allow inspections pursuant tothe ASA; change in control events; revocation or failure by Mesaba to obtain Departmentof Transportation (“DOT”) certification; if Mesaba 

 

 

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or its affiliates operate an aircraft typethat causes Northwest to be in violation of its collective bargaining agreementwith its pilots; failure to elect a chief executive officer/president ofHoldings or Mesaba reasonably acceptable to Northwest; if a specifiedpercentage of the aircraft subject to the agreement are not operated for aspecified period of time, other than as a result of the Federal AviationAdministration (“FAA”) grounding all aircraft for all carriers; if there is astrike; cessation or interruption of work involving Mesaba’s pilots, flightattendants or mechanics providing service; or if Holdings breaches itsagreement entered into with Northwest concurrently with the ASA.

 

Under the ASA, all scheduled flights thatMesaba operates are designated as Northwest flights using Northwest’sdesignator code in all computer reservation systems, with an asterisk and afootnote indicating that Mesaba is the carrier providing the service.  In addition, flight schedules of Mesaba andNorthwest are closely coordinated to facilitate interline connections, andMesaba’s passenger gate facilities at the Minneapolis/St. Paul InternationalAirport, Detroit Metropolitan Airport and Memphis International Airport areintegrated with Northwest’s facilities in the main terminal buildings.

 

Mesaba, through the ASA, receives ticketingand certain check-in, baggage, freight and aircraft handling services fromNorthwest at certain airports.  Inaddition, Mesaba receives its computerized reservations services fromNorthwest.  Northwest also performs allmarketing, scheduling, yield management and pricing services for Mesaba’sflights.

 

The ASA provides for incentive payments fromNorthwest to Mesaba based on achievement of certain operational goals on asemi-annual basis.  Such incentivestotaled $3.7 million, $3.1 million and $4.6 million for fiscal 2006, 2005 and2004, respectively, and are included in passenger revenues in Mesaba’scondensed financial statements (see Note 20).

 

Approximately 79.2% and 88.8% of therespective March 31, 2006 and 2005 net accounts receivable balances in Mesaba’scondensed balance sheets (see Note 20) are due from Northwest and were notcollateralized.  Approximately 94.5% ofMesaba’s operating revenue recognized in fiscal 2006 was from Northwest.  Approximately 92.7% and 92.9% of the Company’sconsolidated operating revenue recognized in fiscal 2005 and 2004,respectively, was from Northwest. Accounts payable owed to Northwest by Mesaba, primarily for groundhandling, was $4.2 million and $0.4 million as of March 31, 2006 and 2005,respectively.

 

Upon execution of the ASA, and pursuant to aseparate agreement between Holdings and Northwest, Holdings issued to Northwestan amended and restated warrant (the “Warrant”) to replace the warrants held byNorthwest to reduce the number of shares of Holdings’ common stock issuableupon exercise from 4,151,922 shares exercisable at prices ranging from $7.25 to$21.25 per share to an aggregate of 4,112,500 shares exercisable at a price of$8.74 per share.  The Warrant expires tenyears from the date of the ASA.  TheWarrant will become exercisable for sixty percent of the shares upon the deliveryby Northwest of the 15th CRJ aircraft to Mesaba and an additional 4% of theshares with each subsequent delivery of each of the next ten CRJ aircraft.

 

As of June 15, 2006, Northwest had deliveredonly two CRJ aircraft to Mesaba. Northwest has advised Mesaba that it will remove one of the CRJs thatMesaba currently operates and place the CRJ with Northwest’s newly formedsubsidiary, Compass Airlines, Inc. (“Compass”) As part of its reorganization, Northwest has also requested bids fromregional airlines for the operation of up to 126 CRJ aircraft, 124 of which arecurrently operated by Pinnacle and two of which are operated by Mesaba.  Mesaba has submitted a proposal to conductall CRJ flying for Northwest.  If Mesabais not awarded some or all of the CRJ business, Northwest will remove the otherCRJ that Mesaba currently operates. Holdings also entered into a registration rights agreement to cover theregistration of the shares of stock currently held by Northwest and the sharesof stock to be issued to Northwest upon exercise of the Warrant.

 

 

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In connection with the ASA, Mesaba incurredall of the start-up costs necessary to bring the CRJ fleet into service.  During fiscal 2006, Mesaba incurred andexpensed approximately $7.0 million in start-up costs related to adding the CRJaircraft into its fleet, and Holdings incurred and expensed approximately $0.3million in related start-up costs.

 

In connection with the ASA, and pursuant toits separate agreement with Northwest, Holdings made a capital contribution ofapproximately $31.7 million to Mesaba in September 2005, just prior toNorthwest filing for bankruptcy (see Note 2 — Investment in Mesaba and Note 3).

 

There are other significant related partytransactions and balances between Northwest and Mesaba disclosed throughout theNotes to the Consolidated Financial Statements. Loss of Mesaba’s business relationship with Northwest or Northwest’sfailure to make timely payment of amounts owed to Mesaba would have a materialadverse effect on Mesaba’s and, therefore, the Company’s, operations, financialposition and cash flows.

 

*Big Sky*

Big Sky operates as a regional air carrierbased in Billings, Montana, providing scheduled passenger, freight, express packageand charter services.  As of March 31,2006, Big Sky provided scheduled air service to 22 communities in Montana,Colorado, Idaho, Oregon, Washington and Wyoming.  Big Sky operates daily scheduled flightsproviding interline and online connecting services and local marketservices.  Big Sky also has code-sharingagreements with Alaska Airlines, Horizon Air, America West Airlines, US Air andNorthwest, where its services are marketed jointly with those air carriers forconnecting flights.

 

Big Sky participates in the Essential AirService (“EAS”) program with the DOT. The EAS program subsidizes air carriers to provide air service todesignated rural communities throughout the United States that could nototherwise economically justify that service based on their passengertraffic.  The DOT pays EAS subsidies foreach departure in a covered market.  BigSky was recently reselected as the EAS provider for seven Montana cities for atwo-year period beginning March 1, 2006 for an additional $1.0 million in EASsubsidies per year.

 

Big Sky purchased fuel at market prices fromNorthwest for $1.4 million, $1.7 million and $1.9 million in fiscal 2006, 2005and 2004, respectively.

 

**2.****             ****Summaryof Significant Accounting Policies**

 

The accounting policies of the Companyconform to accounting principles generally accepted in the United States ofAmerica.  Significant policies aredescribed below.

 

*Basis of Presentation*

The consolidated financial statements includethe accounts of Holdings and its wholly-owned subsidiaries, Big Sky and Mesabauntil its bankruptcy filing on October 13, 2005.  All intercompany transactions and balanceshave been eliminated in consolidation. As discussed below, the accounts of Mesaba have been deconsolidated fromthe Company’s consolidated financial statements effective October 13, 2005.

 

*Use ofEstimates*

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities, as well as the 

 

 

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reported amounts of revenues andexpenses.  The most significant use ofestimates relates to the allowance for doubtful accounts, accrued maintenanceexpenses, aircraft property and equipment lives, inventory obsolescencereserves, valuation of goodwill and other intangible assets and accounting forincome taxes.  Ultimate results coulddiffer from those estimates.

 

*Reclassification*

Certain amounts within shareholders’ equitypreviously reported in the consolidated balance sheet as of March 31, 2005 andconsolidated statements of shareholders’ equity for fiscal 2004 and 2005 have beenreclassified to conform to the fiscal 2006 presentation.  The reclassification had no effect onpreviously reported total shareholders’ equity.

 

*Cashand Cash Equivalents*

Cash equivalents consist primarily of UnitedStates government and municipal securities and interest-bearing deposits withoriginal maturities of less than 90 days and are stated at cost, whichapproximates fair value.  Cashequivalents are generally held to maturity.

 

*Investments*

Investments consist principally ofgovernment, agency, corporate and municipal securities and are classified asavailable-for-sale.  Available-for-saleinvestments are reported at fair value with unrealized gains and lossesexcluded from operations and reported as a separate component of shareholders’equity, except for other-than-temporary impairments, which are reported as acharge to current operations and result in a new cost basis for the investment.

 

*Inventories*

Inventories are stated at the lower of costor market and consist of expendable aircraft service parts, fuel and glycol(de-icing agent).  Mesaba uses the first-in, first-out inventory method,and Big Sky uses average cost.  Expendable parts are charged tomaintenance as used.  A provision is recorded to reduce inventories to theestimated net realizable value, if required.  As of March 31, 2006 and2005, Mesaba’s reserve balance was $4.4 million and $2.2 million,respectively.  Big Sky did not have areserve balance as of March 31, 2006. Big Sky’s reserve balance was $0.1 million as of March 31, 2005.

 

*Propertyand Equipment*

Property and equipment are stated atcost.  Additions, improvements or majorrenewals are capitalized, while expenditures that do not enhance or extend theasset’s useful life are charged to operating expense as incurred.  Depreciation is computed on a straight-linebasis for financial reporting purposes over estimated useful lives of three to40 years.  Leasehold improvements areamortized over the shorter of the life of the lease or the remaining estimateduseful life of the asset.  The Company’sdepreciation and amortization expense on property and equipment was $8.1million, $13.8 million and $16.3 million in fiscal 2006, 2005 and 2004,respectively.

 

 

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TheCompany’s consolidated property and equipment and related accumulateddepreciation and amortization, excluding Mesaba at March 31, 2006 due to itsdeconsolidation effective October 13, 2005 (see Note 20),  were as follows as of March 31, in thousands:

 
| ** **                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Flight equipment                                 |       | $        | 650        |     | $          | 93,645 |   |
| Ground services equipment                        |       | 240      |       | 14,268   |       |
| Office and general  equipment                    |       | 192      |       | 13,189   |       |
| Buildings and leasehold  improvements            |       | 569      |       | 8,321    |       |
| Maintenance shop equipment                       |       | 73       |       | 4,152    |       |
| Other                                            |       | 327      |       | 318      |       |
|                                             |       | 2,051    |       | 133,893  |       |
| Less: Accumulated  depreciation and amortization |       | (628     | )          | (95,472  | )          |
| Net property and equipment                       |       | $        | 1,423      |     | $          | 38,421 |   |

 

Mesaba’s property and equipment and relatedaccumulated depreciation and amortization were as follows as of March 31, inthousands (see Note 20):

 
| ** **                                       | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| Flight equipment                                 |       | $        | 95,357     |     | $          | 92,300 |   |
| Ground services equipment                        |       | 14,349   |       | 14,112   |       |
| Office and general  equipment                    |       | 14,978   |       | 13,040   |       |
| Buildings and leasehold  improvements            |       | 7,685    |       | 7,751    |       |
| Maintenance shop equipment                       |       | 4,361    |       | 4,112    |       |
|                                             |       | 136,730  |       | 131,315  |       |
| Less: Accumulated  depreciation and amortization |       | (104,198 | )          | (94,730  | )          |
| Net property and equipment                       |       | $        | 32,532     |     | $          | 36,585 |   |
|                                                  |            |          |            |          |            |  |  |  |

 

Mesaba’s depreciation and amortizationexpense on property and equipment was $11.6 million, $12.2 million and $14.7million in fiscal 2006, 2005 and 2004, respectively (see Note 20).

 

*Valuation of Long-LivedAssets*

 The Company evaluates long-lived assets forpotential impairments in compliance with SFAS No. 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*. The Company records impairment losses on long-lived assets when events andcircumstances indicate the assets might be impaired and the undiscounted cashflows estimated to be generated by those assets are less than their carryingamounts.  Impairment losses are measured by comparing the fair value ofthe assets to their carrying amounts.  In determining the need to recordimpairment charges, the Company is required to make certain estimates regardingsuch things as the current fair market value of the assets and future net cashflows to be generated by the assets.  The current fair market value isdetermined by independent appraisal or published sales values of similarassets, and the future net cash flows are based on assumptions such as assetutilization, expected remaining useful lives, future market trends andprojected salvage values. Impairment charges are recorded in “Impairment andother charges” on the Company’s or Mesaba’s statements of operations.  Ifthere are subsequent changes in these estimates, or if actual results differfrom these estimates, additional impairment charges may be required.

 

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*OtherAssets*

In connection with the Jet Agreement and AirlinkAgreement, Mesaba paid Northwest contract rights in the form of warrants topurchase an aggregate of 4,151,922 shares of Holdings’ common stock at exerciseprices ranging from $7.25 to $21.25 per share.  Mesaba amortized thecontract rights over the life of the warrants.  Upon execution of the ASA,and pursuant to a separate agreement between Holdings and Northwest, Holdingsissued the amended and restated Warrant to Northwest (see Note 1).  As of March 31, 2006, the Warrant remainedunvested.  When the Warrant was issued, Mesaba wrote off $2.1 million,which amount represented the remaining unamortized portion of the warrantsissued in connection with the Jet Agreement and Airlink Agreement.

 

*Airframeand Engine Maintenance*

Routine airframe and engine maintenance ischarged to expense as incurred.  Overhaulcosts covered by third-party maintenance agreements are accrued based on thehours flown and estimates of aircraft activity. Modifications that enhance the operating performance or extend theuseful lives of airframes or engines are capitalized and amortized over theshorter of the remaining estimated useful life of the asset or the lease term.

 

As discussed in Note 3, there is asignificant amount of uncertainty surrounding Northwest’s fleet plan.  Dueto Northwest’s and Mesaba’s bankruptcy proceedings, Mesaba will not reverseaircraft maintenance accruals until such time as either Northwest’s or Mesaba’sbankruptcy court has formally approved the rejection of aircraft. Therefore, in future periods, Mesaba will appropriately revise its maintenanceestimates as it becomes aware of new information.

* *

*OtherCurrent Liabilities*

TheCompany’s consolidated other current liabilities were as follows as of March31, in thousands:

 
| ** **             | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------|------------|----------|------------|----------|------------|
| Other accrued expenses |       | $        | 5,926      |     | $          | 15,811 |   |
| Taxes payable          |       | 1,198    |       | 1,952    |       |
| Line of credit         |       | 370      |       | 125      |       |
| Property taxes         |       | 192      |       | 2,238    |       |
|                   |       | $        | 7,686      |     | $          | 20,126 |   |

 

Mesaba’s other current liabilities were asfollows as of March 31, in thousands (see Note 20):

 
| ** **             | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------|------------|----------|------------|----------|------------|
| Other accrued expenses |       | $        | 7,885      |     | $          | 11,462 |   |
| Property taxes         |       | 1,583    |       | 4,084    |       |
|                   |       | $        | 9,468      |     | $          | 15,546 |   |

 

 

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*OtherNoncurrent Liabilities*

Inorder to assist the Company in integrating new aircraft into its fleets,certain manufacturers provided Mesaba and Big Sky with spare parts or rentdeferrals.  The Company has deferredthese amounts and amortizes them over the terms of the agreements as areduction of aircraft rent expense.  TheCompany’s amortization of these credits resulted in a reduction of rent expenseof $0.6 million, $1.2 million and $1.5 million during fiscal 2006, 2005 and2004, respectively.  The Company’sconsolidated other noncurrent liabilities were as follows as of March 31, inthousands:

 
| ** **                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
| Manufacturers credits             |       | $        | 323        |     | $          | 3,653 |   |
| Deferred rent                     |       | 37       |       | 1,861    |       |
| Long-term debt and capital  lease |       | 412      |       | 555      |       |
|                              |       | $        | 772        |     | $          | 6,069 |   |

 

Mesaba’s amortization of these creditsresulted in a reduction of rent expense of $1.8 million, $1.2 million and $1.8million in fiscal 2006, 2005 and 2004, respectively.  Mesaba’s other noncurrent liabilities were asfollows as of March 31, in thousands (see Note 20):

 
| ** **            | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------|------------|----------|------------|----------|------------|
| Manufacturers credits |       | $        | 743        |     | $          | 3,506 |   |
| Deferred rent         |       | 1,804    |       | 1,861    |       |
|                  |       | $        | 2,547      |     | $          | 5,367 |   |

 

*StockOptions*

The Company accounts for its stock-basedcompensation using the intrinsic value method prescribed under AccountingPrinciples Board (“APB”) Opinion No. 25, *Accounting for StockIssued to Employees*, and related interpretations.  The Company has issued stock options todirectors and key employees.  As such,the Company records compensation expense for stock options and awards only ifthe exercise price is less than the fair market value of the stock on themeasurement date.

 

For purposes of the pro forma disclosures ofcompensation expense under Statement of Financial Accounting Standards (“SFAS”)No. 123, *Accounting for Stock-Based Compensation*,the Company uses the Black-Scholes option model to estimate the fair value ofoptions.  The weighted average fair valueof options granted during fiscal 2005 was $3.41.  Weighted average assumptions used in thevaluation for the years ended March 31 are summarized below:

 
| ** **                                | ** ** | **2006*** | ** ** | **2005**    | ** ** | **2004*** | ** ** |
|-------------------------------------------|------------|-----------|------------|-------------|------------|-----------|------------|
| Risk free interest rate  (%)              |       | N/A       |       | 1.8  to 3.2 |       | N/A       |       |
| Expected life of option  grants (years)   |       | N/A       |       | 4.0  to 4.6 |       | N/A       |       |
| Expected volatility of  option grants (%) |       | N/A       |       | 46.7        |       | N/A       |       |

 

*There were no options granted in eitherfiscal 2006 or 2004.

 

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Thefollowing summarizes the pro forma effects assuming compensation for suchawards had been recorded based upon the estimated fair value for each of theyears ended March 31, in thousands, except per share information:

 
| ** **                                                                | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income as reported                                                    |       | $        | (82,848    | )        | $          | 7,355    |       | $ | 4,496 |   |
| Add: Stock-based employee  compensation (reduction) expense               |       |     |       |     |       |     |       |
| included in reported net income, net of related tax effects               |       | (1,436   | )          | (13      | )          | 1,987    |       |
| Deduct: Stock-based  employee compensation expense determined             |       |     |       |     |       |     |       |
| under fair value based method for all awards, net of related tax  effects |       | (808     | )          | (1,187   | )          | (1,234   | )          |
|                                                                      |       | $        | (85,092    | )        | $          | 6,155    |       | $ | 5,249 |   |
| Earnings per share -  basic:                                              |       |     |       |     |       |     |       |
| As reported                                                               |       | $        | (4.02      | )        | $          | 0.36     |       | $ | 0.22 |   |
| Pro forma                                                                 |       | $        | (4.13      | )        | $          | 0.30     |       | $ | 0.26 |   |
|                                                                      |       |     |       |     |       |     |       |
| Earnings per share -  diluted:                                            |       |     |       |     |       |     |       |
| As reported                                                               |       | $        | (4.02      | )        | $          | 0.35     |       | $ | 0.22 |   |
| Pro forma                                                                 |       | $        | (4.13      | )        | $          | 0.29     |       | $ | 0.26 |   |
|                                                                           |            |          |            |          |            |          |            |  |  |  |  |  |  |  |  |

 

*Investment in Mesaba*

As discussed in Note 1, Holdings hasaccounted for Mesaba’s financial results under the equity method of accountingsince Mesaba’s bankruptcy filing on October 13, 2005.  In accordance with APB Opinion No. 18, **The EquityMethod of Accounting for Investments in Common Stock****,**Holdingsevaluated whether its investment in Mesaba has experienced another-than-temporary impairment as of March 31, 2006.  Holdings’ evaluation utilized a market andincome approach, including a discounted cash flow analysis.  After analyzing Mesaba’s actual losses infiscal 2006, (which increased significantly during the fourth quarter of fiscal2006 after the February 28, 2006 bar date — see Note 3), projected losses infiscal 2007 as it transitions to a Saab-only operation, Mesaba’s five-year Saabbusiness plan and Mesaba’s liabilities subject to compromise as of March 31,2006, Holdings concluded that its remaining investment in Mesaba hadexperienced an other-than-temporary impairment. Accordingly, effective March 31, 2006, Holdings recorded an $8.9 millionimpairment charge to write off its remaining equity investment in Mesaba.  The impairment charge was recorded in “Impairmentand other charges” in the fiscal 2006 consolidated statement of operations.

 

*RevenueRecognition*

Mesaba recognizes passenger revenue asservices are provided.  For flightsutilizing the Saabs, Mesaba recognizes revenue for each completed ASM.  For flights utilizing the Avros, Mesabarecognizes revenue for each block hour flown. For flights utilizing the CRJs, Mesaba recognizes revenue throughmonthly expense reimbursement payments for actual expenses incurred relating toaircraft rent, maintenance, landing fees and fuel (which is set at a fixedprice of $0.70 per gallon for the CRJs); semi-monthly payments for each blockhour and cycle operated; a monthly fixed cost payment based on the size of theCRJ fleet (intended to cover Mesaba’s costs that are not reimbursed through themonthly reimbursement payments, which consist mainly of labor costs, groundhandling costs, overhead and depreciation) and margin payments based on therevenues described above calculated to achieve a target operating margin.

 

In addition, the ASA includes semi-annualincentive payments based upon achievement of certain operational targets, suchas completion factor and on-time performance. Such incentives are earned and due based on performance over a givenperiod (generally six months).  Inperiods prior to the finalization of such operational incentives, revenue isrecognized when the targets have been exceeded. The amount recognized is limited to a ratable portion of the incentivepayment as if the contract period were to terminate at the end of the interimperiod.

 

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Big Sky recognizes revenue whentransportation has been provided, including scheduled passenger, airfreight,express package and charter services.

 

*IncomeTaxes*

The Company accounts for income taxes underthe asset and liability method whereby deferred income tax assets andliabilities are computed annually for differences between the financial statementand tax bases of assets and liabilities. These differences will result in taxable or deductible amounts in thefuture based on enacted tax laws and rates applicable to the periods in whichthe differences are expected to affect taxable income.

 

Under the provisions of SFAS No. 109, *Accounting for Income Taxes*, the realization of the futuretax benefits of a deferred tax asset is dependent on future taxable incomeagainst which such tax benefits can be applied. All available evidence must beconsidered in the determination of whether sufficient future taxable incomewill exist. Such evidence includes, but is not limited to, the Company’sfinancial performance, the market environment in which the Company operates,the utilization of past tax credits, and the length of relevant carryback andcarryforward periods. Sufficient negative evidence, such as cumulative netlosses during a three-year period that includes the current year and the priortwo years, may require that a valuation allowance be established with respectto existing and future deferred tax assets. A valuation allowance is recorded when deferred tax assets are notconsidered more likely than not to be realized.

* *

*FairValue of Financial Instruments*

The Company’s financial instruments consistprimarily of cash, cash equivalents, accounts receivable, accounts payable,accrued liabilities and other noncurrent liabilities of which carrying amountsdo not significantly differ from fair value due to their short-term nature orvariable interest rates.  See Note 7 foradditional information regarding the Company’s investments.

 

*NewAccounting Pronouncements*

In May 2005, the Financial AccountingStandards Board (“FASB”) issued Statement of Accounting Standards (“SFAS”) No.154, *Accounting Changes and Error Corrections*,a replacement of APB Opinion No. 20 and FASB Statement No. 3.  SFAS No. 154 requires retrospectiveapplication to prior periods’ financial statements for changes in accountingprinciple, unless it is impracticable to determine either the period-specificeffects or the cumulative effect of the change. SFAS No. 154 also requires that retrospective application of a change inaccounting principle be limited to the direct effects of the change.  Indirect effects of a change in accountingprinciple, such as a change in non-discretionary profit-sharing paymentsresulting from an accounting change, should be recognized in the period of theaccounting change.  SFAS No. 154 alsoprovides that a change in depreciation, amortization, or depletion method forlong-lived, non-financial assets be accounted for as a change in accountingestimate effected by a change in accounting principle.  SFAS No. 154 carries forward without changethe guidance contained in APB Opinion No. 20 for reporting the correction of anerror in previously issued financial statements and a change in accountingestimate and the guidance in APB Opinion No. 20 requiring justification of achange in accounting principle on the basis of preferability.  SFAS No.154 will be effective for the Company on April 1, 2006.

 

In December 2004, the FASB issued SFAS No.123(R), *Share-Based Payment*, which is a revisionof SFAS No. 123. SFAS No. 123(R) supersedes APB Opinion No. 25 and amends SFASNo. 95, *Statement of Cash Flows*. The revisionrequires companies to measure and recognize compensation expense for allshare-based payments to employees, including grants of employee stock options,in the financial statements based on the fair value at the date of the grant.SFAS No. 123(R) permits companies to adopt its requirements using either themodified prospective method or the modified retrospective method. 

 

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Under the modified prospective method,compensation cost is recognized beginning with the effective date for allshare-based payments granted after the effective date and for all awardsgranted to employees prior to the effective date of SFAS No. 123(R) that remainunvested on the effective date. The modified retrospective method includes therequirements of the modified prospective method, but also permits entities torestate either all prior periods presented or prior interim periods of the yearof adoption for the impact of adopting this standard. The Company will applythe modified prospective method upon adoption. In April 2005, the Securitiesand Exchange Commission announced it would provide for phased-in implementationof SFAS No. 123(R). As a result, SFAS No. 123(R) is effective for the firstinterim or annual reporting period of the registrant’s first fiscal yearbeginning on or after June 15, 2005. The Company projects that compensationexpense related to employee stock options issued as of March 31, 2006 will beapproximately $0.3 million in fiscal 2007. SFAS No. 123(R) also requires the benefits of tax deductions in excessof recognized compensation costs to be reported as financing cash flow, ratherthan as an operating cash flow as required under current literature. Thisrequirement will reduce net operating cash flows and increase net financingcash flows in periods after adoption. Management believes that thisreclassification will not have a material impact on the Company’s consolidatedstatements of cash flows.

 

**3.****             ****Northwestand Mesaba Bankruptcy Filings**

 

*NorthwestBankruptcy Filing*

On September 12, 2005, Northwest failed tomake a payment of approximately $18.7 million due to Mesaba for servicesprovided by Mesaba to Northwest from August 15 to August 31, 2005.  Subsequently, on September 14, 2005,Northwest filed in the Southern District of New York for bankruptcy protectionunder Chapter 11 of the Bankruptcy Code. On September 26, 2005, Northwest made a payment of approximately $1.6million to Mesaba, which payment was to be for services provided by Mesaba toNorthwest from September 1 to September 15, 2005.  Because Northwest’s bankruptcy petition wasfiled on September 14, Northwest paid only that portion of the paymentattributable to services provided by Mesaba post-petition.  Additionally, on October 11, 2005, Northwestpaid Mesaba approximately $15.7 million for services provided by Mesaba fromSeptember 16 to September 30, 2005. Northwest deducted approximately $3.3 million from the total amount duefor amounts that Northwest asserts represent prepetition claims against Mesaba.  On October 26, 2005, Northwest paid Mesabaapproximately $10.5 million for services provided by Mesaba from October 1 toOctober 15, 2005.  Northwest deductedapproximately $6.1 million from the total amount due, the majority of whichrelated to aircraft payments Mesaba did not make to Northwest following Mesaba’sown bankruptcy filing on October 13, 2005 (see below).

 

At the time of Northwest’s bankruptcy filingon September 14, 2005, Mesaba estimated that Northwest owed Mesabaapproximately $31.9 million under the ASA and related agreements, net ofamounts that Mesaba owed to Northwest under these agreements.  After analyzing the collectibility of theprepetition receivables due to Mesaba from Northwest, the Company concludedthat it was necessary to establish a reserve of $31.9 million for amounts thatMesaba may not ultimately collect from Northwest and is included in “Impairmentand other charges” in the accompanying fiscal 2006 consolidated statement ofoperations.

 

As of March 31, 2006, Mesaba updated itsreserve balance to $29.1 million, based on revised estimates of $36.4 millionowed by Northwest to Mesaba and $7.3 million owed by Mesaba to Northwest.  The decrease in the reserve of $2.8 millionrecorded by Mesaba since October 13, 2005 has been included in “Impairment andother charges” in Mesaba’s condensed financial statements (see Note 20).  Although Mesaba recorded the above provision,Mesaba will continue to actively seek reimbursement through the bankruptcyprocess and any other means, including any future discussions Mesaba may havewith Northwest regarding the ASA.

 

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Generally, all amounts that Northwest owed toits creditors at the time of its filing were stayed by the bankruptcy filing.  Mesaba’s claims relating to such prepetitionamounts are unsecured claims.  Northwest’sbankruptcy court has established August 16, 2006 as the last date and time forthe filing of proofs of claim against Northwest.  All claims that arose on or prior toSeptember 14, 2005, the date of Northwest’s bankruptcy filing, must be filed ona proof of claim by the bar date.

 

At any time during Northwest’s bankruptcyproceedings, Northwest has the option to assume or reject the ASA and relatedagreements, pending approval of the bankruptcy court and a committeerepresenting Northwest’s unsecured creditors. If Northwest assumes the ASA, prepetition amounts owed to Mesaba wouldbecome an administrative claim and Mesaba could receive payment in full.  If Northwest rejects the ASA and relatedcontracts, then prepetition amounts owed to Mesaba would remain an unsecuredclaim, and Mesaba would likely receive only a small percentage of the amountsowed to it, and even then would only receive such amounts after Northwest’splan of reorganization is approved by its bankruptcy court.  Mesaba believes that, even if Northwestintends to assume the ASA, Northwest will attempt to renegotiate the ASA withMesaba before Northwest will seek to assume the ASA.  This renegotiation could include anegotiation of the amount that Northwest will ultimately pay Mesaba insettlement of the net prepetition amounts that Northwest owes to Mesaba.  However, the exact nature of Mesaba’s futurerelationship with Northwest may not be known until such time as Northwest andMesaba adopt their respective bankruptcy reorganization plans.

 

Since its bankruptcy filing, Northwest hasalso proposed and implemented various changes to Mesaba’s fleet.  Northwest idled nine of the Avros operated byMesaba from Northwest’s schedule effective October 31, 2005.  In addition, Northwest idled an additionalthree Avros and removed 11 Saabs from the schedule effective January 4,2006.  As of March 31, 2006, Mesaba wasoperating 23 Avros, 52 Saabs and two CRJs pursuant to the ASA.  Northwest has removed two Saabs and sevenAvros effective June 8, 2006 and intends to terminate all the remainingaircraft, other than 49 Saabs, by the end of calendar 2006, subject to finallease negotiations between Northwest and its lessors.  Northwest has advised Mesaba that it willremove one of the CRJs that Mesaba operates and place it with Northwest’s newlyformed subsidiary, Compass.  Finally,Northwest issued a request for proposal for flying up to 126 CRJs and notifiedMesaba that if it is not awarded any additional CRJs, Northwest will remove theremaining CRJ operated by Mesaba.  Mesabaintends to compete to operate the additional CRJs.  However, Mesaba also expects that itscompetitors, many with greater financial resources, will also seek to operatesuch aircraft.

 

*MesabaBankruptcy Filing*

Northwest’s missed payments to Mesaba andNorthwest’s actions regarding its fleet and schedule changes adversely affectedMesaba.  Specifically, Mesaba determinedthat due to Northwest’s failure to make the September 12, 2005 payment, thedeductions taken by Northwest against subsequent payments and the reducedrevenues Mesaba would receive because of the fleet and schedule changesdictated by Northwest, Mesaba could not sustain its operations outside of courtprotection under Chapter 11 of the Bankruptcy Code.  As a result, on October 13, 2005 (the “PetitionDate”), Mesaba filed for bankruptcy protection under Chapter 11 of theBankruptcy Code.  Mesaba continues tooperate its business as a debtor-in-possession under the jurisdiction of theBankruptcy Court and in accordance with the applicable provisions of theBankruptcy Code, the Federal Rules of Bankruptcy Procedure and applicable courtorders.  In general, as adebtor-in-possession, Mesaba is authorized under Chapter 11 to continue tooperate as an ongoing business, but may not engage in transactions outside theordinary course of business without the prior approval of the Bankruptcy Court.

 

All of Mesaba’s vendors are being paid forall goods furnished and services provided to Mesaba after the Petition Date inthe ordinary course of business. However, under Section 362 of the Bankruptcy Code, actions to collectmost of Mesaba’s prepetition liabilities are automatically stayed, except forliabilities 

 

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relating to certain qualifying aircraft,aircraft engines and other aircraft-related equipment that are leased orsubject to a security interest or conditional sale contract.  Under Section 1110 of the Bankruptcy Code,actions to collect such aircraft-related prepetition liabilities areautomatically stayed for 60 days after the Petition Date, except under twoconditions:  (a) the debtor may extendthe 60-day period by agreement with the relevant financier or lessor and withcourt approval; or (b) the debtor may agree to perform all of the obligationsunder the applicable lease or financing and cure any defaults as required underthe Bankruptcy Code.  If neither of theseconditions is met, the lessor or financier may demand the return of theaircraft and enforce any of its contractual rights or remedies to sell, leaseor otherwise retain or dispose of such property.

 

On January 12, 2006, the Bankruptcy Courtapproved Mesaba’s rejection of the leases for 11 Saab B model aircraft leasedfrom Pinnacle.  Northwest and Mesabainitially agreed to extend the Section 1110 deadline with respect to aircraftMesaba leases or subleases from Northwest. Although that agreement has expired, Mesaba continues to use theaircraft in accordance with Northwest’s scheduling requests and is performingunder the subleases.  Because theaircraft currently operated by Mesaba are subleased from Northwest, Mesaba’sdecision with respect to such aircraft will be timed with Northwest’s fleetplans during Northwest’s bankruptcy.

 

Under Section 365 of the Bankruptcy Code,Mesaba may assume, assume and assign, or reject certain executory contracts andunexpired leases, including leases of real property, subject to the approval ofthe Bankruptcy Court and certain other conditions.  Mesaba’s original Section 365 deadlinerelated to real estate leases was December 12, 2005.  One June 6, 2006, the Bankruptcy Courtextended the Section 365 deadline to the earlier of confirmation of a reorganizationplan or December 10, 2006.  In general,if Mesaba rejects an executory contract or unexpired lease, it is treated as aprepetition breach of the lease or contract in question and, subject to certainexceptions, relieves Mesaba of performing any future obligations.  However, such a rejection entitles the lessoror contract counterparty to a prepetition general unsecured claim for damagescaused by such deemed breach and, accordingly, the counterparty may file aclaim against Mesaba for such damages. As a result, liabilities subject to compromise of $60.0 million reportedin Mesaba’s condensed balance sheet as of March 31, 2006 (see Note 20) arelikely to change in the future as a result of damage claims created by Mesaba’srejection of various aircraft leases, executory contracts and unexpiredleases.  Generally, if Mesaba assumes anaircraft financing agreement, executory contract or unexpired lease, Mesaba isrequired to cure existing defaults under such contract or lease as a conditionto such assumption.

 

The bar date for non-governmental entities tofile proofs of claim against Mesaba was February 28, 2006 (the “Bar Date”).  Proofs of claim aggregating $216.8 millionwere filed by that date.  Mesaba’smanagement and bankruptcy counsel have reviewed and assessed these proofs ofclaim to eliminate duplicative claims and claims without merit, as well as toadjust the amounts of certain proofs of claim based on management’s estimate ofthe likelihood that the claim will be allowed by the Bankruptcy Court.  As of March 31, 2006, Mesaba estimated thevalue of the allowable claims at $60.0 million. See Note 20 for further discussion of Mesaba’s liabilities subject tocompromise.

 

Pursuant to Mesaba’s request fordebtor-in-possession financing, in October 2005, Holdings provided a $35million commitment letter and term sheet to Mesaba for such financing.  At Mesaba’s request, Holdings extended thedeadline for the expiration of the commitment letter two times.  On March 24, 2006, the commitment expired.  Mesaba is seeking debtor-in-possessionfinancing from other sources, but there can be no assurance that Mesaba will beable to obtain such financing on acceptable terms.  If Mesaba is unable to obtaindebtor-in-possession financing or otherwise generate sufficient cash by the endof the second quarter of fiscal 2007, Mesaba could be forced intoliquidation.  Holdings has no obligationto fund Mesaba’s operations but may consider investing in Mesaba once Mesabadevelops a plan of reorganization.

 

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To successfully emerge from Chapter 11, inaddition to obtaining exit financing if needed, the Bankruptcy Court mustconfirm a plan of reorganization, the filing of which will depend on the timingand outcome of numerous ongoing matters in the Chapter 11 process andpotentially including the outcome of Northwest’s Chapter 11 case.  Mesaba intends to file a plan ofreorganization as soon as it is able to do so, but there can be no assurancethat the Bankruptcy Court will confirm a plan of reorganization or that anysuch plan will be implemented successfully. The reorganization plan will determine the rights and claims of variouscreditors and security holders.  At thistime, it is not possible to predict accurately the effect of the Chapter 11reorganization process on Mesaba’s business, nor can Mesaba make anypredictions concerning how the various creditor claims and interests ofsecurity holders will be determined in the bankruptcy proceedings.

 

**4.****             ****Goodwilland Other Intangible Assets**

 

The Company purchased Big Sky in December2002.  The excess of the Big Sky purchaseprice over the fair market value of the net assets acquired was allocated tocertain identifiable intangible assets, including Big Sky’s pilot labor contractand its air carrier certificate, and to goodwill.  Goodwill and the intangible assets areevaluated for impairment annually, at a minimum, or on an interim basis ifevents or circumstances indicate a possible inability to realize the carryingamounts.

 

Due to the continued rising costs of fuel andthe resulting operating losses at Big Sky, the Company determined that aninterim impairment test of goodwill and other intangible assets was necessaryat September 30, 2005.  The goodwillimpairment tests requires the Company to compare the fair value of thereporting unit to its carrying amount to determine if there is potentialimpairment. If the fair value of the reporting unit is less than its carryingvalue, an impairment loss is recorded to the extent that the fair value of thegoodwill and other intangible assets within the reporting unit is less thantheir carrying value. If the carrying amount of the goodwill and otherintangible assets exceeds their fair value, an impairment loss is recognized. Fairvalues for goodwill and other intangible assets are determined based ondiscounted cash flows.

 

Based on the results of the interim testperformed at September 30, 2005, the Company determined that goodwill wasimpaired and recorded an impairment charge of approximately $2.5 million.  The impairment charge was recorded in “Impairmentand other charges” in the accompanying fiscal 2006 consolidated statement ofoperations.  Based on its analysis, theCompany determined that the air carrier certificate and pilot labor contractwere not impaired, but will continue to monitor the intangible assets at BigSky for potential impairment in the future.

 

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Goodwilland other intangible assets and related accumulated amortization were asfollows for the years ended March 31, in thousands:

 
| ** **                           | ** ** | **2006**   | ** ** | **2005**         | ** ** |
|--------------------------------------|------------|------------|------------|------------------|------------|
| ** **                           | ** ** | ** ** | ** ** | **Accumulated**  | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Gross**  | ** ** | **Amortization** | ** ** | **Net** | ** ** | **Gross** | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Indefinite-lived  intangible assets: |       |       |       |             |       |   |   |   |   |   |   |   |   |
| Air carrier certificate              |       | $          | 925        |             |       |   | $ | 925 |   | $ | 925 |   |   |   | $ | 925 |   |
| Goodwill                             |       | —     |       |             |       | — |   | 2,503 |   |   |   | 2,503 |   |
| Amortizable intangible  asset:       |       |       |       |             |       |   |   |   |   |   |   |   |   |
| Pilot labor contract                 |       | 2,840      |       | (1,352           | )          | 1,488 |   | 2,840 |   | (946 | ) | 1,894 |   |
|                                 |       | $          | 3,765      |             | $          | (1,352 | ) | $ | 2,413 |   | $ | 6,268 |   | $ | (946 | ) | $ | 5,322 |   |
|                                      |            |            |            |                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The amortizable intangible asset is beingamortized over its estimated period of benefit. Based on the current amount of intangible assets subject toamortization, estimated amortization expense for each of the succeeding fivefiscal years will be $0.4 million per year. The recoverability of goodwill and the intangible assets is evaluatedannually, at a minimum, or on an interim basis if events or circumstancesindicate a possible inability to realize the carrying amounts.  During the fourth quarter of fiscal 2006, theCompany completed its annual impairment test of intangible assets anddetermined that no additional impairment charge was necessary.

 

**5.****             ****Impairmentand Other Charges**

 

Impairment and other charges for the yearended March 31, 2006 were as follow, in thousands:

 
| ** **                                                      | ** ** | ** ** | ** ** | **Refer to** | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|--------------|------------|
| ** **                                                      | ** ** | **2006**   | ** ** | **Note**     | ** ** |
| Cancellation of Northwest  warrants                             |       | $          | 2,106      |         | 2          |   |
| Provision for loss  associated with Northwest bankruptcy filing |       | 31,900     |       | 3            |       |
| Impairment of Big Sky  goodwill                                 |       | 2,503      |       | 4            |       |
| Provision for guaranty of  Cincinnati hangar lease              |       | 4,759      |       | 9            |       |
| Impairment of investment  in Mesaba                             |       | 8,935      |       | 2            |       |
|                                                            |       | $          | 50,203     |         |       |   |

 

Mesaba reduced impairment and other charges$2.8 million in the last six months of fiscal 2006 to adjust the Northwest baddebt reserve to $29.1 million from $31.9 million primarily due to additionaloffsetting liabilities owed by Mesaba to Northwest.  The $2.8 million reduction was determined afterthe deconsolidation of Mesaba on the Petition Date (see Note 3) and isreflected in Mesaba’s condensed financial statements (see Note 20).

 

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**6.****             ****Holdings’Proof of Claim in Mesaba’s Bankruptcy**

 

OnFebruary 28, 2006, as a part of Mesaba’s bankruptcy proceedings, Holdings fileda proof of claim against Mesaba for $55.2 million.  The following table summarizes Holdings’claim against Mesaba, in thousands:

 
| Management fees                                                        |   | $      | 2,875  |   |
|------------------------------------------------------------------------|--------|--------|--------|--------|
| Guaranty of principal and  accrued interest on Cincinnati hangar bonds |   | 13,015 |   |
| Guaranty of Cincinnati  hangar lease                                   |   | 4,501  |   |
| Capital contribution to  Mesaba made in connection with ASA            |   | 31,755 |   |
| Federal and state income  taxes                                        |   | 3,080  |   |
|                                                                   |   | $      | 55,226 |   |

 

As of March 31, 2006, Holdings has notrecorded a receivable for its $55.2 million claim against Mesaba within theCompany’s consolidated financial statements and will not record its claim untilthe Bankruptcy Court determines which claims, if any, will be allowed into theclaim pool.

 

In conjunction with the deconsolidation ofMesaba’s results following the Petition Date, the Company reviewed allintercompany guaranties.  The Companyidentified liabilities of approximately $6.0 million for the guaranty of Mesaba’sCincinnati/Northern Kentucky International Airport facility and certain Mesabaincome tax obligations payable to Holdings as the filer of the Company’sconsolidated tax returns. These liabilities recorded on Holdings’ financialstatements are duplicative of similar amounts included in liabilities subjectto compromise recorded in Mesaba’s condensed financial statements (see Note 20)and have been eliminated from Holdings’ March 31, 2006 consolidated financialstatements.

 

Under guidance of SOP 90-7 and APB OpinionNo. 18, the Company has determined that it is probable that the duplicativeliabilities will be allowed into the claim pool by the Bankruptcy Court.  Mesaba has accrued $6.0 million asreorganization items related to these duplicative liabilities.  Therefore, the $40.0 million of the equity inloss of Mesaba that Holdings recognized at March 31, 2006 does not include the$6.0 million in duplicative liabilities Mesaba has recorded in fiscal 2006.

 

**7.****             ****Investments**

 

Investments consist principally ofgovernment, agency, corporate and municipal securities and are classified asavailable-for-sale.  Fair value ofinvestments is determined based on quoted market prices.  The Company classifies investments with anoriginal maturity of more than 90 days that mature within one year asshort-term and greater than one year as long-term.

 

As of March 31, 2006 and 2005, cash, cashequivalents, short-term and long-term investments totaled $110.7 million(excluding $30.7 million held by Mesaba) and $170.9 million (including suchcash and investments held by Mesaba), respectively.

 

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Amortizedcost, gross unrealized gains and losses and fair value of short and long-terminvestments classified as securities available for sale were as follows as ofMarch 31, in thousands:

 
| ** **              | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Amortized cost          |       | $        | 63,761     |     | $          | 113,346 |   |
| Gross unrealized gains  |       | 4        |       | 3        |       |
| Gross unrealized losses |       | (164     | )          | (440     | )          |
| Fair value              |       | $        | 63,601     |     | $          | 112,909 |   |
|                         |            |          |            |          |            |  |  |  |

 

 

At March 31, 2006, Mesaba’s amortized costand fair value of short- and long-term investments classified as securitiesavailable for sale were $10.0 million, of which gross unrealized gains andlosses were insignificant.

 

In fiscal 2006, gross realized losses were$0.2 million as the Company incurred some losses when it changed its investmentprofile focus from tax-exempt municipal securities to taxable securities.  In fiscal 2005 and 2004, the gross realizedgains and losses were insignificant, as the Company generally held theinvestments until maturity.

 

 

**8.****             ****Leases**

 

*AircraftLeases*

Mesaba

Mesaba’sairline fleet consisted of the following aircraft held under operating leasesas of March 31, 2006:

 
| ** **           | ** ** | ** **    | ** ** | ** **   | ** ** | **Approximate**   | ** ** | **Approximate**      | ** ** |
|----------------------|------------|---------------|------------|--------------|------------|-------------------|------------|----------------------|------------|
| ** **           | ** ** | **Number of** | ** ** | **Seating**  | ** ** | **Single Flight** | ** ** | **Average Cruising** | ** ** |
| **Type of Aircraft** | ** ** | **Aircraft**  | ** ** | **Capacity** | ** ** | **Range (miles)** | ** ** | **Speed (mph)**      | ** ** |
| Avro RJ85            |       | 23            |       | 69           |       | 1,400             |       | 400                  |       |
| Saab 340             |       | 52            |       | 30/34        |       | 500               |       | 300                  |       |
| CRJ 200/440          |       | 2             |       | 50           |       | 1,500             |       | 500                  |       |

 

Under the terms of the ASA, Mesaba leases orsubleases its Avro aircraft from Northwest under operating leases with initialterms of up to ten years that expire in 2007. The Avro lease and sublease agreements with Northwest contain certainrequirements of Mesaba regarding the payment of taxes on the aircraft,acceptable use of the aircraft, the level of insurance to be maintained, themaintenance procedures to be performed and the condition of the aircraft upontheir return to Northwest.  The ASAallows Mesaba to return Avros to Northwest upon the occurrence of certainevents, including termination of the ASA.

 

Shortly after Northwest filed for bankruptcy,it unilaterally, and in breach of the ASA, removed 12 Avros from Mesaba’sflight schedule, and Mesaba discontinued recording or paying any rent on theseleases through March 31, 2006. Mesaba and Northwest then entered into a written agreement under whichNorthwest acknowledged that Mesaba was not required to make sublease paymentson the idled aircraft.  That agreementexpired in February 2006.  Mesaba choseto wait to reject the subleases until it was confident that Northwest would notreturn the idled aircraft to the flight schedule.  In May 2006, Northwest formally rejected itsleases related to the idled Avros.  Toensure that Northwest’s actions have relieved Mesaba of all liability orobligations arising under the subleases, on June 13, 2006, Mesaba filed amotion with the Bankruptcy Court to seek formal approval of Mesaba’s rejectionof the subleases for the 12 idled aircraft. Mesaba believes that under Section 503(b)(1) of the BankruptcyCode, which 

 

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governs administrative claims, Northwestwould have no standing to assert an administrative claim against Mesaba for theaircraft rent because Northwest had previously agreed that Mesaba had noobligation to pay rent for grounded aircraft and because Mesaba parked andprotected the aircraft at Northwest’s request.

 

Mesaba leases three of its Saab aircraftdirectly from aircraft leasing companies on a month to month basis, and theremainder through subleases with Northwest under operating leases with initialterms of up to 17 years that expire between 2014 and 2016.  The lease and sublease agreements with theaircraft leasing companies and Northwest contain certain requirements of Mesabaregarding the payment of taxes on the aircraft, acceptable use of the aircraft,the level of insurance to be maintained, the maintenance procedures to beperformed and the condition of the aircraft upon their return.  The ASA allows Mesaba to return Saab aircraftto Northwest upon the occurrence of certain events, including termination ofthe ASA.

 

Mesaba subleases its two CRJs from Northwestunder operating leases with initial terms of up to ten years that expire in2015.  The lease agreements containcertain requirements of Mesaba regarding the payment of taxes on the aircraft,acceptable use of the aircraft, the level of insurance to be maintained, themaintenance procedures to be performed and the condition of the aircraft upontheir return to Northwest.  Northwest reimbursesMesaba’s aircraft rental expense in full under the ASA.

 

Mesaba’s aircraft leases do not contain anyguaranteed lease residual provisions for which there would be a potentialcontingency at the termination of the lease period.

 

As of March 31, 2006, the above aircraftoperating leases for non-idled aircraft for Mesaba require future minimumrental payments as follows, in thousands:

 
| **Year Ending March 31** | ** ** | **Amount** | ** ** |
|--------------------------|------------|------------|------------|
| 2007                     |       | $          | 49,826     |   |
| 2008                     |       | 34,503     |       |
| 2009                     |       | 34,503     |       |
| 2010                     |       | 34,503     |       |
| 2011                     |       | 34,503     |       |
| Thereafter               |       | 139,975    |       |
|                     |       | $          | 327,813    |   |

 

 

 

 

The information in the table above is basedon Mesaba’s current assessment of its future fleet composition.  Accordingly, the lease agreements for 23Avros that had scheduled future minimum rental payments of $40.6 million peryear through fiscal 2016 are not included in the above table (other than $14.6million in fiscal 2007) as these remaining 23 Avros will be removed by December31, 2006.  The table above also excludesamounts associated with the 12 Avros idled and removed from the fleet byNorthwest during fiscal 2006.  IfNorthwest’s fleet decisions change in the future, Mesaba’s future minimumrental payments will change accordingly.

 

Mesaba’s rent expense for aircraft operatingleases was $93.0 million, $100.5 million and $103.0 million in fiscal 2006,2005 and 2004, respectively (including $73.9 million, $59.5 million and $66.0million paid to Northwest in fiscal 2006, 2005 and 2004, respectively).  See Note 20.

 

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BigSky

Big Sky’s airline fleet consisted of thefollowing aircraft held under operating leases as of March 31, 2006:

 
| ** **           | ** ** | ** **    | ** ** | ** **   | ** ** | **Approximate**   | ** ** | **Approximate**      | ** ** |
|----------------------|------------|---------------|------------|--------------|------------|-------------------|------------|----------------------|------------|
| ** **           | ** ** | **Number of** | ** ** | **Seating**  | ** ** | **Single Flight** | ** ** | **Average Cruising** | ** ** |
| **Type of Aircraft** | ** ** | **Aircraft**  | ** ** | **Capacity** | ** ** | **Range (miles)** | ** ** | **Speed (mph)**      | ** ** |
| Operating:           |       |          |       |         |       |              |       |                 |       |
| Beechcraft 1900D     |       | 10            |       | 19           |       | 750               |       | 325                  |       |
| Nonoperating:        |       |          |       |         |       |              |       |                 |       |
| Metro III            |       | 4             |       |         |       |              |       |                 |       |

 

Big Sky’s fleet consisted of 14 aircraftcovered under operating leases with remaining terms of 17 to 56 months andaggregate monthly lease payments of approximately $0.2 million.  Big Sky leases its aircraft from leasingcompanies and from Mesa Airlines, Inc. As of March 31, 2006 Big Sky had accrued $0.8 million to estimate the leaseand return expenses of the four nonoperating Metro III aircraft.

 

BigSky’s aircraft operating leases do not contain any guaranteed lease residualprovisions for which there would be a potential contingency at the terminationof the lease period.  As of March 31,2006, the aircraft operating leases for Big Sky require future minimum rentalpayments as follows, in thousands:

 
| **Year Ending March 31** | ** ** | **Amount** | ** ** |
|--------------------------|------------|------------|------------|
| 2007                     |       | $          | 1,810      |   |
| 2008                     |       | 1,810      |       |
| 2009                     |       | 1,810      |       |
| 2010                     |       | 1,719      |       |
| 2011                     |       | 392        |       |
| Thereafter               |       | —     |       |
|                     |       | $          | 7,541      |   |
|                          |            |            |            |  |  |

 

Consolidated rent expense for aircraftoperating leases, excluding Mesaba after its deconsolidation on October 13,2005, was $56.3 million, $102.5 million and $105.5 million in fiscal 2006, 2005and 2004, respectively.

 

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*Non-AircraftLeases*

TheCompany leases land, offices, hangar facilities, equipment and certain terminalfacilities under operating leases through 2019, which provide for approximatefuture minimum rental payments as follows as of March 31, in thousands:

 
| **Year Ending March 31** | ** ** | **Amount** | ** ** |
|--------------------------|------------|------------|------------|
| 2007                     |       | $          | 1,428      |   |
| 2008                     |       | 1,343      |       |
| 2009                     |       | 1,327      |       |
| 2010                     |       | 1,365      |       |
| 2011                     |       | 1,323      |       |
| Thereafter               |       | 23,403     |       |
|                     |       | $          | 30,189     |   |

 

The Company’s consolidated rent expense fornon-aircraft operating leases was approximately $1.1 million, $15.4 million and$16.2 million in fiscal 2006, 2005 and 2004, respectively.

 

Separately, as described in Note 14, Holdingshas guaranteed Mesaba’s obligations with respect to Mesaba’s facility at theCincinnati/Northern Kentucky International Airport.  Since Mesaba’s bankruptcy filing, Holdingshas made the payments owed by Mesaba under the ground lease and facilitieslease, which payments total approximately $1.2 million annually.  These guaranty payments are reflected in thetable above.

 

Mesabaleases land, offices, hangar facilities, equipment and certain terminalfacilities under operating leases through 2028, which provide for approximatefuture minimum rental payments as follows as of March 31, in thousands:

 
| **Year Ending March 31** | ** ** | **Amount** | ** ** |
|--------------------------|------------|------------|------------|
| 2007                     |       | $          | 4,184      |   |
| 2008                     |       | 3,545      |       |
| 2009                     |       | 3,570      |       |
| 2010                     |       | 3,453      |       |
| 2011                     |       | 3,332      |       |
| Thereafter               |       | 25,038     |       |
|                     |       | $          | 43,122     |   |

 

Mesaba’s expense for non-aircraft operatingleases was approximately $12.6 million, $14.7 million and $15.9 million infiscal 2006, 2005 and 2004, respectively (see Note 20).

 

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*CapitalLease*

Futureminimum lease payments under Big Sky’s capital lease for its hangar facilityand the present value of future minimum capital lease payments as of March 31,were as follows, in thousands:

 
| **Year Ending March 31**                 | ** ** | **Amount** | ** ** |
|------------------------------------------|------------|------------|------------|
| 2007                                     |       | $          | 68         |   |
| 2008                                     |       | 68         |       |
| 2009                                     |       | 68         |       |
| 2010                                     |       | 68         |       |
| 2011                                     |       | 68         |       |
| Thereafter                               |       | 261        |       |
| Total minimum lease  payments            |       | $          | 601        |   |
| Less interest                            |       | (178       | )          |
| Present value of minimum  lease payments |       | $          | 423        |   |

 

The carrying value of the facility undercapital lease net of accumulated depreciation was $0.5 million at both March31, 2006 and 2005.

 

**9.****             ****NotesPayable and Long-Term Debt**

 

Long-termdebt is recorded in other noncurrent liabilities in the consolidated balancesheet and consists of the following as of March 31, in thousands:

 
| ** **                                                                                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Variable rate installment note (8.75% at March 31, 2006) due May 2007  secured by substantially all assets of Big Sky |       | $        | 27         |     | $          | 47 |   |
| 7.5% installment note due May 2007 secured by substantially all assets  of Big Sky                                    |       | 106      |       | 190      |       |
|                                                                                                                  |       | 133      |       | 237      |       |
| Capitalized lease obligation, at imputed interest rate of 8.5%,  secured by Big Sky leased assets                     |       | 423      |       | 456      |       |
|                                                                                                                  |       | 556      |       | 693      |       |
| Less current portion                                                                                                  |       | (144     | )          | (138     | )          |
|                                                                                                                  |       | $        | 412        |     | $          | 555 |   |

 

Long-term debt maturities were as follows asof March 31, 2006, in thousands:

 
| **Year Ending March 31** | ** ** | **Amount** | ** ** |
|--------------------------|------------|------------|------------|
| 2007                     |       | $          | 144        |   |
| 2008                     |       | 55         |       |
| 2009                     |       | 40         |       |
| 2010                     |       | 43         |       |
| 2011                     |       | 47         |       |
| Thereafter               |       | 227        |       |
|                     |       | $          | 556        |   |

 

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*Line ofCredit*

InFebruary 2005, Big Sky obtained a revolving line of credit in the principalamount of $250,000 from First Interstate Bank of Billings.  In March 2006, the principal amount availableunder the line increased to $370,000. The line of credit charges a variable interest rate based on the primerate published in the *Wall Street Journal*.  At March 31, 2006, the rate was 7.75%.  The line of credit is collateralized by BigSky’s inventory, accounts receivable and equipment and is scheduled to maturein January 2007.  The balance of the lineof credit was $0.4 million and $0.1 million as of March 31, 2006 and 2005,respectively.

 

**10.****      ****Income Taxes**

 

TheCompany’s consolidated provision (benefit) for income taxes, excluding Mesabaafter its deconsolidation on October 13, 2005, was comprised of the following elementsfor the years ended March 31, in thousands:

 
| Current: | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------|------------|----------|------------|----------|------------|----------|------------|
| Federal  |       | $        | (2,418     | )        | $          | 2,328    |       | $ | 4,786 |   |
| State    |       | —   |       | 850      |       | 585      |       |
| Deferred |       |     |       |     |       |     |       |
| Federal  |       | (10,453  | )          | 390      |       | (1,289   | )          |
| State    |       | (971     | )          | 36       |       | (119     | )          |
|     |       | $        | (13,842    | )        | $          | 3,604    |       | $ | 3,963 |   |

 

The actual income tax expense differs fromthe statutory tax expense as follows for the years ended March 31, inthousands:

 
| ** **                                                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Computed tax (benefit)  expense at Federal statutory rate of 35% |       | $        | (19,858    | )        | $          | 3,830    |       | $ | 3,065 |   |
| Increase (decrease) in  income taxes resulting from:             |       |     |       |     |       |     |       |
| State taxes, net of federal tax benefit                          |       | (1,845   | )          | 553      |       | 380      |       |
| Non-deductible meals and entertainment expenses                  |       | 264      |       | 393      |       | 385      |       |
| Non-deductible goodwill impairment                               |       | 957      |       | —   |       | —   |       |
| Non-deductible loss in subsidiary                                |       | 3,418    |       | —   |       | —   |       |
| IRS audit settlement                                             |       | —   |       | (1,200   | )          | —   |       |
| Valuation allowance                                              |       | 3,630    |       | —   |       | —   |       |
| Other, net                                                       |       | (408     | )          | 28       |       | 133      |       |
|                                                             |       | $        | (13,842    | )        | $          | 3,604    |       | $ | 3,963 |   |
|                                                                  |            |          |            |          |            |          |            |  |  |  |  |  |  |

 

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Thefollowing is a table of the significant components of the Company’s deferredtax assets and liabilities as of March 31, in thousands:

 
| ** **                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:                               |       |     |       |     |       |
| Maintenance                                        |       | $        | 1          |     | $          | 7,413 |   |
| Warrants                                           |       | —   |       | 1,407    |       |
| Inventories                                        |       | —   |       | 861      |       |
| Net operating loss (“NOL”) carryforwards |       | 2,871    |       | 1,280    |       |
| Other accruals                                     |       | 2,327    |       | 7,570    |       |
| Gross deferred tax assets                          |       | $        | 5,199      |     | $          | 18,531 |   |
|                                               |       |     |       |     |       |
| Deferred tax liabilities:                          |       |     |       |     |       |
| Property and equipment                             |       | $        | 142        |     | $          | 2,780 |   |
| Other accruals                                     |       | 1,427    |       | 1,625    |       |
| Gross deferred tax  liabilities                    |       | 1,569    |       | 4,405    |       |
| Less valuation allowance                           |       | (3,630   | )          | —   |       |
| Net deferred tax assets                            |       | $        | —     |     | $          | 14,126 |   |
|                                                    |            |          |            |          |            |  |  |  |

 

Thenet deferred tax asset was classified as follows as of March 31, in thousands:

 
| ** ** | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------|------------|----------|------------|----------|------------|
| Current    |       | $        | —     |     | $          | 11,709 |   |
| Long term  |       | —   |       | 2,417    |       |
|       |       | $        | —     |     | $          | 14,126 |   |

 

Consolidated

SFAS No. 109, *Accountingfor Income Taxes*, requires that all available evidence, bothpositive and negative, be considered to determine whether, based on the weightof that evidence, a valuation allowance is needed.  Future realization of the tax benefits of anexisting deductible temporary difference or carryforward ultimately depends onthe existence of sufficient taxable income of the appropriate character withinthe carryback or carryforward periods available under the tax law.

 

The Company has performed such an analysis,and a valuation allowance has been provided against deferred tax assets to theextent they cannot be used to offset future income arising from the expectedreversal of taxable differences.  Avaluation allowance of $3.6 million has been provided due to the significanceof the Company’s losses and significant uncertainties of its ability to realizethese assets.  The Company will berequired to update its estimates of future taxable income based upon additionalinformation management obtains, and the Company will continue to evaluate therealizability of the deferred tax assets on a quarterly basis.

 

Deferred income taxes reflect the net taxeffects of temporary differences between the carrying amounts of assets andliabilities for financial reporting purposes and the amounts used for incometax purposes.  At March 31, 2006, theCompany’s federal deferred tax assets included $7.1 million of net operatingloss (“NOL”) carryforwards (excluding Mesaba’s NOL carryforwards discussedbelow).  Of these NOL carryforwards,$3.7 million are federal NOLs related to Big Sky and are subject toSection 382 of the Internal Revenue Code, which restricts the annualutilization of certain NOLs incurred prior to a change 

 

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in ownership. These Big Sky NOL carryforwards expire through 2022.  The remaining balance is made up of $3.4million in federal NOLs, which expire in 2026, and $10.5 million in state NOLs,which expire over the next five to twenty years.

 

During the first quarter of fiscal 2005, theCompany received verification of a final settlement with the Internal RevenueService (“IRS”) concerning the IRS’ examination of the Company’s fiscal 1995and 1996 income tax returns.  As a resultof this settlement, the Company reduced its income tax payable and taxprovision by $1.2 million in the first quarter of fiscal 2005.

 

As a result of the deconsolidation of Mesabain the third quarter of fiscal 2006, all of Mesaba’s net deferred tax assetsare no longer presented in the accompanying consolidated balance sheet at March31, 2006 but remain a part of Mesaba’s condensed financial statements at March31, 2006 (see Note 20).  Holdings stillowns 100% of Mesaba, and Holdings will continue to include Mesaba in itsconsolidated tax return filings as long as Holdings owns at least 80% ofMesaba.

 

Mesaba

 

Mesaba’s provision (benefit) for income taxeswas comprised of the following elements for the years ended March 31, inthousands:

 
| Current: | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------|------------|----------|------------|----------|------------|----------|------------|
| Federal  |       | $        | (3,443     | )        | $          | 5,853    |       | $ | 5,679 |   |
| State    |       | —   |       | 544      |       | 527      |       |
| Deferred |       |     |       |     |       |     |       |
| Federal  |       | 10,844   |       | 196      |       | 266      |       |
| State    |       | 1,007    |       | 18       |       | 25       |       |
|     |       | $        | 8,408      |     | $          | 6,611    |       | $ | 6,497 |   |
|          |            |          |            |          |            |          |            |  |  |  |  |

 

The actual income tax expense differs fromthe statutory tax expense as follows for the years ended March 31, inthousands:

 
| ** **                                                       | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Computed tax (benefit)  expense at Federal statutory rate of 35% |       | $        | (21,814    | )        | $          | 5,150    |       | $ | 4,528 |   |
| Increase (decrease) in income taxes resulting from:              |       |     |       |     |       |     |       |
| State taxes, net of federal tax benefit                          |       | (2,026   | )          | 504      |       | 420      |       |
| Non-deductible meals and entertainment expenses                  |       | 533      |       | 383      |       | 408      |       |
| Non-deductible amortization expenses                             |       | 1,062    |       | 626      |       | 616      |       |
| Non-deductible reorganization expenses                           |       | 1,550    |       | —   |       | —   |       |
| Deferred tax asset valuation allowance                           |       | 27,736   |       | —   |       | —   |       |
| Other, net                                                       |       | 1,367    |       | (52      | )          | 525      |       |
|                                                             |       | $        | 8,408      |     | $          | 6,611    |       | $ | 6,497 |   |

 

 

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Thefollowing is a table of the significant components of Mesaba’s deferred taxassets and liabilities as of March 31, in thousands:

 
| ** **                                         | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax assets:                               |       |     |       |     |       |
| Maintenance                                        |       | $        | 6,424      |     | $          | 7,337 |   |
| Allowance for doubtful accounts                    |       | 5,778    |       | 216      |       |
| Inventories                                        |       | 1,667    |       | 820      |       |
| Net operating loss (“NOL”) carryforwards |       | 2,189    |       | —   |       |
| Liabilities subject to compromise                  |       | 9,857    |       | —   |       |
| Other accruals                                     |       | 4,585    |       | 6,772    |       |
| Gross deferred tax assets                          |       | 30,500   |       | 15,145   |       |
|                                               |       |     |       |     |       |
| Deferred tax liabilities:                          |       |     |       |     |       |
| Property and equipment                             |       | $        | 2,640      |     | $          | 2,476 |   |
| Other accruals                                     |       | 124      |       | 298      |       |
| Gross deferred tax liabilities                     |       | 2,764    |       | 2,774    |       |
| Less valuation allowance                           |       | (27,736  | )          | —   |       |
| Net deferred tax assets                            |       | $        | —     |     | $          | 12,371 |   |
|                                                    |            |          |            |          |            |  |  |  |

 

Mesaba’s net deferred tax asset wasclassified as follows as of March 31, in thousands:

 
|      |   | **2006** | ** ** | **2005** |   |
|-----------|--------|----------|------------|----------|--------|
| Current   |   | $        | —     |     | $      | 11,063 |   |
| Long term |   | —   |       | 1,308    |   |
|      |   | $        | —     |     | $      | 12,371 |   |

 

SFAS No. 109 requires that all availableevidence, both positive and negative, be considered to determine whether, basedon the weight of that evidence, a valuation allowance is needed.  Future realization of the tax benefits of anexisting deductible temporary difference or carryforward ultimately depends onthe existence of sufficient taxable income of the appropriate character withinthe carryback or carryforward periods available under the tax law.

 

Deferred income taxes reflect the net taxeffects of temporary differences between the carrying amounts of assets andliabilities for financial reporting purposes and the amounts used for incometax purposes.  At March 31, 2006, Mesaba’sdeferred tax assets included $4.9 million of federal NOLs which expire in 2026and $15.0 million of state NOL carryforwards which expire over the next five totwenty years.  The NOL carryforwards availableare subject to limitations on their annual usage.

 

Due to Mesaba’s losses resulting fromcreditors’ bankruptcy claims during the fourth quarter of fiscal 2006,reductions in its fleet and the future income projections of a downsizedoperation, management determined that the realization of all deferred taxassets from future profitable operations was not more likely than not as ofMarch 31, 2006.  Under thesecircumstances, deferred tax assets may only be recognized to the extent suchbenefits may be realized through future reversals of taxable temporarydifferences.  Mesaba has performed suchan analysis, and a valuation allowance has been provided against deferred taxassets to the extent they cannot be used to offset future income arising fromthe expected reversal of taxable differences. A valuation allowance in the amount of $27.7 million has been 

 

 

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provided to reduce the gross amount of theseassets to the extent necessary to result in an amount that is more likely thannot of being realized.

 

Further, Section 382 of the Internal RevenueCode provides that certain transfers of Mesaba’s equity, or issuances of equityin connection with its restructuring, may impair Mesaba’s ability to utilizeits NOL carryforwards in the future. Under federal income tax law, a corporation is generally permitted todeduct from taxable income in any year NOLs carried forward from prior years.  As mentioned above, Mesaba has NOLcarryforwards which expire at various times over the next twenty years. Mesaba’sability to deduct NOL carryforwards could be subject to a significantlimitation if Mesaba undergoes an ownership change during or as a result of itsChapter 11 proceedings.  Mesaba canprovide no assurance that its bankruptcy reorganization will not result in anownership change that may limit its ability to utilize its NOLcarryforwards.  Due to Mesaba’s inabilityunder generally accepted accounting principles to assume future profits and itsreduced ability to implement tax planning strategies to utilize its NOLs whilein bankruptcy, Mesaba concluded that a valuation allowance was required.

 

**11.****      ****Shareholders’ Equity**

 

*CapitalStock*

The Company’s authorized capital stockconsists of 60,000,000 shares of common stock, par value $0.01 per share, and1,000,000 shares of undesignated preferred stock, having no specified parvalue.  As of March 31, 2006, there were20,591,840 shares of common stock issued and outstanding.  No shares of preferred stock have been issued.

 

Holders of common stock are entitled to onevote per share on any matter presented to shareholders for approval.  The common stock has no special voting rightsor dividend preferences.  Holders ofcommon stock are not allowed cumulative voting and do not possess anypreemptive rights to acquire any new or additional shares of stock of theCompany.  Dividends are paid if and whendeclared by the Company’s board of directors. In the event of a liquidation of the Company, holders of common stockwould be entitled to a pro rata distribution of any proceeds remaining afterpayment to all of the Company’s creditors.

 

The Company’s board of directors has theauthority to designate one or more series of preferred stock, and to fix thedesignations, powers, preferences, rights, qualifications, limitations andrestrictions of such series.  If sodesignated by the board of directors, the shares of any series of preferredstock could be senior to the common stock with respect to distributions.

 

*StockOption Plans*

The Company has approved stock option plansfor key employees, directors, consultants and advisors to the Company.  Options have been granted and are presentlyoutstanding under the Company’s 1994 Stock Option Plan, 1996 Director StockOption Plan and 2000 Stock Incentive Plan. The 2000 Stock Incentive Plan has a provision that automaticallyincreases the authorized shares available for grant on September 1 of each yearby the lesser of 300,000 or 1% of the then outstanding common shares.  Under the plans, the compensation committeeof the board of directors grants the options with vesting and exercise periodbeing determined at the time of the award. The purchase price of the stock for non-qualified and incentive stockoptions is determined at the time of the award and is generally equal to thefair market value at the time of the award.

 

 

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Stockoption transactions for the above three plans for the three years ended March31 were as follows:

 
| ** **                | ** ** | **Options**     | ** ** | **Weighted Average** | ** ** | **Options**     | ** ** | **Weighted Average** | ** ** |
|---------------------------|------------|-----------------|------------|----------------------|------------|-----------------|------------|----------------------|------------|
| ** **                | ** ** | **Outstanding** | ** ** | **Exercise Price**   | ** ** | **Exercisable** | ** ** | **Exercise Price**   | ** ** |
| Balance at March 31, 2003 |       | 2,132,500       |       | $                    | 6.91       |            | 973,475    |                 | $          | 6.94 |   |
| Exercised                 |       | (54,731         | )          | 6.51                 |       |            |       |                 |       |
| Cancelled                 |       | (293,250        | )          | 7.17                 |       |            |       |                 |       |
| Balance at March 31, 2004 |       | 1,784,519       |       | 6.88                 |       | 1,203,519       |       | 6.90                 |       |
| Granted                   |       | 330,000         |       | 8.28                 |       |            |       |                 |       |
| Exercised                 |       | (198,968        | )          | 6.04                 |       |            |       |                 |       |
| Cancelled                 |       | (17,000         | )          | 23.00                |       |            |       |                 |       |
| Balance at March 31, 2005 |       | 1,898,551       |       | 7.07                 |       | 1,272,426       |       | 6.85                 |       |
| Exercised                 |       | (17,500         | )          | 6.54                 |       |            |       |                 |       |
| Cancelled                 |       | (321,875        | )          | 8.04                 |       |            |       |                 |       |
| Balance at March 31, 2006 |       | 1,559,176       |       | 6.87                 |       | 1,341,676       |       | 6.74                 |       |
|                           |            |                 |            |                      |            |                 |            |                      |            |  |  |

 

Options outstanding as of March 31, 2006 wereas follows:

 
| ** **          | ** **                      | **Options Outstanding** | ** ** | **Options Exercisable**               | ** ** |
|---------------------|---------------------------------|-------------------------|------------|---------------------------------------|------------|
| **Range of**        | ** **                      | **Number**              | ** ** | **Average Remaining   Contract Life** | ** ** | **Weighted   Average** | ** ** | **Number** | ** ** | **Weighted   Average** | ** ** |
| **Exercise Prices** | ** **                      | **of Shares**           | ** ** | **(in years)**                        | ** ** | **Exercise Price** | ** ** | **of Shares** | ** ** | **Exercise Price** | ** ** |
| $                   | 5.97  - $   6.90 |                    | 1,124,176  |                                  | 4.4        |   | $ | 6.18 |   | 1,064,176 |   | $ | 6.19 |   |
| $                   | 6.90  - $   9.20 |                    | 385,000    |                                  | 6.8        |   | 8.45 |   | 227,500 |   | 8.57 |   |
| $                   | 9.20  - $ 11.50            |                    | 50,000     |                                  | 2.1        |   | 10.00 |   | 50,000 |   | 10.00 |   |
| $                   | 5.97  - $ 11.50            |                    | 1,559,176  |                                  | 4.9        |   | 6.87 |   | 1,341,676 |   | 6.74 |   |
|                     |                                 |                         |            |                                       |            |  |  |  |  |  |  |  |  |  |

 

As of March 31, 2006, there were 1,327,965shares available for grant under the Company’s 2000 Stock Incentive Plan.  No shares are available for futuregrants under either the 1994 Stock Option Plan or the 1996 DirectorStock Option Plan.

 

In December 2002, the Company repriced stockoptions to purchase 745,000 shares of the Company’s common stock with exerciseprices ranging from $9.05 to $18.00 to an exercise price of $5.97, whichrepresented the fair market value on the date of the repricing.  In accordance with FASB Interpretation No.44, *Accounting for Certain Transactions Involving StockCompensation*, the Company has adopted variable plan accounting forthese options from the date of the repricing. In fiscal 2006, the Company recorded a reduction to compensation expenseof $1.4 million.  In fiscal 2005, theCompany had an immaterial reduction to compensation expense related to therepriced options.  In fiscal 2004, theCompany recorded compensation expense of $2.0 million as a result of therepricing.  As of March 31, 2006, thereremained outstanding repriced stock options exercisable for an aggregate of404,782 shares of common stock.

 

**12.****      ****Earnings Per Share**

 

Basic earnings per common share is computedby dividing net income by the weighted average number of shares of common stockoutstanding during the year.  Dilutedearnings per share is computed by dividing net income by the sum of theweighted average number of shares of common stock outstanding plus all 

 

 

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additional common stock that would have beenoutstanding if potentially dilutive common shares related to stock options andwarrants had been exercised.  Stockoptions and warrants with an exercise price exceeding the fair market value ofthe Company’s common stock at year-end are considered antidilutive and areexcluded from the calculation.  Thefollowing table reconciles the number of shares utilized in the earnings pershare calculations for the years ended March 31, in thousands, except per sharedata:

 
| ** **                                                                                | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net income (loss)                                                                         |       | $        | (82,848    | )        | $          | 7,355    |       | $ | 4,496 |   |
| For earnings per share — basic:                                                      |       |     |       |     |       |     |       |
| Weighted average number of issued shares outstanding                                      |       | 20,584   |       | 20,505   |       | 20,334   |       |
| Effect of dilutive securities:                                                            |       |     |       |     |       |     |       |
| Computed shares outstanding under stock option plans utilizing the  treasury stock method |       | —   |       | 388      |       | 226      |       |
| Computed shares outstanding under warrants issued utilizing the  treasury stock method    |       | —   |       | 157      |       | 2        |       |
| For earnings per share — diluted:                                                    |       |     |       |     |       |     |       |
| Weighted average common and potentially dilutive common shares  outstanding               |       | 20,584   |       | 21,050   |       | 20,562   |       |
| Earnings (loss) per share — basic                                                    |       | $        | (4.02      | )        | $          | 0.36     |       | $ | 0.22 |   |
| Earnings (loss) per share — diluted                                                  |       | $        | (4.02      | )        | $          | 0.35     |       | $ | 0.22 |   |
| Antidilutive options and warrants                                                         |       | 5,672    |       | 3,505    |       | 3,522    |       |

 

 

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**13.****      ****Segment Information**

 

TheCompany follows the provisions of SFAS No. 131, *Disclosuresabout Segments of an Enterprise and Related Information*.  SFAS No. 131 establishes annual and interimreporting standards for an enterprise’s business segments and relateddisclosures about its products, services, geographic areas and majorcustomers.  The method for determiningwhat information to report is based upon the way management organizes theoperating segments within the Company for making operating decisions andassessing financial performance. Although Mesaba has been deconsolidated from the Company’s condensedconsolidated financial statements as of the Petition Date, the segmentinformation presented below continues to include Mesaba in accordance with SFASNo. 131 and related guidance for equity-method investees.  Mesaba’s results of operations after thePetition Date are included in the “Eliminations” column.

 

Operatingsegment information for Mesaba, Big Sky and Holdings were as follows, inthousands:

 
| ** **                           | ** ** | **Mesaba** | ** ** | **Big Sky** | ** ** | **Holdings** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------|------------|------------|------------|-------------|------------|--------------|------------|------------------|------------|------------------|------------|
| *Year Ended March 31, 2006:*         | * *   | * *   | * *   | * *    | * *   | * *     | * *   | * *         | * *   | * *         | * *   |
| Operating revenues                   |       | $          | 408,814    |        | $          | 20,441       |       | $                | 3,184      |             | $          | (176,160 | ) | $ | 256,279 |   |
| Operating expenses                   |       | 448,939    |       | 28,225      |       | 21,086       |       | (179,270         | )          | 318,980          |       |
| Depreciation and amortization        |       | 12,243     |       | 878         |       | 18           |       | (5,012           | )          | 8,127            |       |
| Interest expense                     |       | —     |       | 390         |       | —       |       | (315             | )          | 75               |       |
| Reorganization items, net            |       | 23,395     |       | —      |       | —       |       | (23,395          | )          | —           |       |
| Income (loss) before income taxes    |       | (62,326    | )          | 8,090       |       | (12,106      | )          | 9,605            |       | (56,737          | )          |
| Capital expenditures                 |       | 8,101      |       | 743         |       | 20           |       | (2,382           | )          | 6,482            |       |
| At year end:                         |       |       |       |        |       |         |       |             |       |             |       |
| Current assets                       |       | 78,284     |       | 3,926       |       | 98,437       |       | (82,211          | )          | 98,436           |       |
| Total assets                         |       | 118,441    |       | 7,918       |       | 169,716      |       | (174,133         | )          | 121,942          |       |
| Current liabilities                  |       | 52,984     |       | 9,591       |       | 6,908        |       | (56,912          | )          | 12,571           |       |
| Total stockholders' equity (deficit) |       | 2,937      |       | (2,445      | )          | 169,716      |       | (61,609          | )          | 108,599          |       |
| *Year Ended March 31, 2005:*         | * *   | * *   | * *   | * *    | * *   | * *     | * *   | * *         | * *   | * *         | * *   |
| Operating revenues                   |       | $          | 427,533    |        | $          | 15,077       |       | $                | 4,774      |             | $          | (4,774 | ) | $ | 442,610 |   |
| Operating expenses                   |       | 413,077    |       | 19,991      |       | 5,677        |       | (4,774           | )          | 433,971          |       |
| Depreciation and amortization        |       | 13,844     |       | 774         |       | 16           |       | —           |       | 14,634           |       |
| Interest expense                     |       | —     |       | 278         |       | —       |       | (217             | )          | 61               |       |
| Income (loss) before income taxes    |       | 14,715     |       | (5,182      | )          | 1,426        |       | —           |       | 10,959           |       |
| Capital expenditures                 |       | 9,390      |       | 264         |       | 5            |       | —           |       | 9,659            |       |
| At year end:                         |       |       |       |        |       |         |       |             |       |             |       |
| Current assets                       |       | 75,926     |       | 3,273       |       | 110,918      |       | (2,570           | )          | 187,547          |       |
| Total assets                         |       | 120,877    |       | 11,308      |       | 161,271      |       | (12,502          | )          | 280,954          |       |
| Current liabilities                  |       | 73,580     |       | 7,768       |       | 3,428        |       | (2,570           | )          | 82,206           |       |
| Total stockholders' equity           |       | 41,930     |       | 2,838       |       | 157,843      |       | (9,932           | )          | 192,679          |       |
| *Year Ended March 31, 2004:*         | * *   | * *   | * *   | * *    | * *   | * *     | * *   | * *         | * *   | * *         | * *   |
| Operating revenues                   |       | $          | 416,318    |        | $          | 16,471       |       | $                | 3,726      |             | $          | (3,726 | ) | $ | 432,789 |   |
| Operating expenses                   |       | 406,162    |       | 20,097      |       | 6,230        |       | (3,726           | )          | 428,763          |       |
| Depreciation and amortization        |       | 16,299     |       | 836         |       | 9            |       | —           |       | 17,144           |       |
| Interest expense                     |       | —     |       | 300         |       | 1            |       | (200             | )          | 101              |       |
| Income (loss) before income taxes    |       | 12,639     |       | (3,664      | )          | (516         | )          | —           |       | 8,459            |       |
| Capital expenditures                 |       | 10,661     |       | 25          |       | 31           |       | —           |       | 10,717           |       |

 

 

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**14.****      ****Commitments and Contingencies**

 

*Workforce*

Approximately 40% of Mesaba’s workforce aremembers of unions representing pilots, mechanics, dispatchers and flightattendants.  As a part of its bankruptcyproceedings, Mesaba sought approval from the Bankruptcy Court to reject theexisting collective bargaining agreements (“CBAs”) with all four unions andimpose new contract terms on each labor union. On January 31, 2006, the Bankruptcy Court approved Mesaba’s tentativeagreement reached with the TWU, the union for Mesaba’s dispatchers.  In February and March 2006, the BankruptcyCourt heard testimony from Mesaba and the remaining three unions for Mesaba’spilots, mechanics and flight attendants. On May 18, 2006, the Bankruptcy Court denied Mesaba’s motion to reject.  Although the Bankruptcy Court agreed withMesaba’s core economic arguments, the court ruled that Mesaba failed to satisfycertain technical elements required to authorize rejection of the laborcontracts.  The Bankruptcy Court statedthat if Mesaba chooses to remedy the defects in its original motion, the courtwould hear a renewed motion in a prompt manner. On June 12, 2006, Mesaba filed a renewed motion for authority to rejectits CBAs, and the Bankruptcy Court began hearing the motion on June 26, 2006.

 

Approximately 43% of Big Sky’s workforce aremembers of unions representing pilots, mechanics and dispatchers.  The CBAs for the pilots, mechanics anddispatchers become amendable December 2009, August 2010 and December 2009,respectively.

 

*BenefitPlan*

Mesaba maintains a 401(k) benefit plan foreligible employees of Holdings and Mesaba whereby Holdings or Mesaba will match25% to 125% of employee contributions to the plan, up to 10% of each employee’seligible earnings, depending on the employee’s length of service.  Holdings’ expense related to the plan wasinsignificant in fiscal 2006.  Mesaba’sexpense related to the plan totaled $3.3 million in fiscal 2006.  The Company’s expense related to the plan was$3.9 million and $2.0 million in fiscal 2005 and 2004, respectively.

 

Big Sky maintains a 401(k) benefit plancovering substantially all of its employees whereby Big Sky will match 30% ofemployee contributions to the plan, up to 5% of each employee’s eligibleearnings.  Big Sky’s contribution to theplan was not significant in fiscal 2006, 2005 or 2004.

 

*StockAppreciation Rights Plan*

During fiscal 2004, Mesaba approved a stockappreciation rights (“SAR”) plan for key employees and directors.  The exercise price of each SAR is generallyequal to the fair market value of the Company’s common stock on the date of theaward.  Cash is paid based on thedifference between the fair market value at the date of grant and the date theSAR is exercised.

 

During fiscal 2006, no SARs were issued.  During fiscal 2005, 365,000 SARs were issuedat a weighted average exercise price of $7.89 per SAR with four year vestingand expiration in ten years.  Duringfiscal 2006, 322,500 SARs were cancelled due to employee terminations and27,500 were exercised.  During fiscal2005, 50,000 SARs were cancelled due to employee terminations and none wereexercised.  Compensation expense of $0.1million was recognized in fiscal 2005, and no compensation expense wasrecognized in fiscal 2006.

 

*RegulatoryMatters*

Mesaba and Big Sky are parties to ongoing FAAproceedings arising in the ordinary course of business.  In the opinion of management, the resolutionof these matters will not have a material adverse effect on the Company’sconsolidated financial position, results of operations or cash flows.

 

 

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*Litigation*

The Company is a party to ongoing legal andtax proceedings arising in the ordinary course of business.  In the opinion of management, the resolutionof these matters will not have a material adverse effect on the Company’sconsolidated financial position, results of operations or cash flows.  See Note 3 for a discussion of Mesaba’sbankruptcy proceedings.

 

*SaabLeasing Litigation*

On October 4, 2002, Fairbrook Leasing, Inc.,Lambert Leasing, Inc. and Swedish Aircraft Holdings AB (“Saab Leasing”) filed adeclaratory judgment action against Mesaba relating to 20 Saab 340A (“340A”)aircraft leased by Mesaba.  Saab Leasingsought a judicial declaration that the terms of the leases applicable to eachof the 340A aircraft are governed by a March 7, 1996 term sheet proposal ratherthan the parties’ subsequent agreements and conduct.  In a December 8, 2003 order, the DistrictCourt for the District of Minnesota (the “District Court”) declared the termsheet proposal a binding preliminary agreement requiring Mesaba to negotiate ingood faith toward the execution of long-term agreements for each of the 340Aaircraft.  Mesaba appealed the DistrictCourt’s ruling.

 

On August 13, 2004, relying on the DistrictCourt’s declaratory judgment ruling, Saab Leasing filed a separate action inthe District Court alleging approximately $35 million in damages for past dueand future aircraft lease obligations. Mesaba denied the allegations in Saab Leasing’s complaint and contendedthat it had fulfilled and would continue to fulfill its existing obligations.

 

On May 19, 2005, the United States Court ofAppeals for the Eighth Circuit (the “Court of Appeals”) affirmed the DistrictCourt’s declaratory judgment ruling. Despite the Court of Appeals’ ruling, Mesaba believes, based on advicefrom its legal counsel, that it has defenses in the damages case that willlimit Saab Leasing’s ability to recover damages.  On September 9, 2005, the District Courtheard oral arguments on Saab Leasing’s and Mesaba’s cross-motions for summaryjudgment.  The District Court did notrule on these motions prior to Mesaba’s bankruptcy petition.

 

On October 14, 2005, Mesaba notified theDistrict Court that Mesaba applied for debtor protection under Chapter 11 ofthe Bankruptcy Code and that such application operates to automatically staythe continuation of the Saab Leasing matter. On January 19, 2006, the Bankruptcy Court denied Saab Leasing’s motionfor relief from the automatic stay and held that Saab Leasing could notcontinue with the case until at least May 1, 2006.  On June 16, 2006, the Bankruptcy Courtapproved Mesaba’s and Saab Leasing’s stipulation modifying the automatic stayfor the limited purpose of permitting the District Court to rule on thecross-motions for summary judgment. There can be no assurance that the District Court will grant Mesaba’smotion for summary judgment.  Therefore,the ultimate outcome of this dispute cannot be predicted with certainty.  Ultimately, the amount of any damages awardto Saab Leasing would be deemed an unsecured prepetition claim againstMesaba.  As of March 31, 2006, Mesaba hadnot established any accrual with regard to this litigation within its condensedfinancial statements (see “Item 8. Financial Statements and Supplemental Data,Note 20 — Financial Information of Mesaba”).

 

*OtherLitigation Matters*

Mesaba is also a defendant in variouslawsuits arising in the ordinary course of business.  While the outcome of these lawsuits andproceedings cannot be predicted with certainty, it is the opinion of Mesaba’smanagement based on current information and legal advice that the ultimatedisposition of these suits will not have a material adverse effect on theseparate financial statements of Mesaba.

 

*Guaranty*

Mesaba currently leases a hangar facility atthe Cincinnati/Northern Kentucky International Airport.  Holdings has unconditionally guaranteed fulland prompt payment of the bonds associated with the initial financing of thefacility.  In October 2005, following itsbankruptcy filing, Mesaba vacated the facility 

 

 

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due to the reduced number of Avros that willrequire maintenance in the future.  Inaccordance with its guaranty, Holdings has been making the monthly ground andfacilities lease payments of $0.1 million per month since November 2005.  Additionally, on February 15, 2006, Holdingsreceived notice that the trustee for the bondholders declared Holdings’liability for all sums to be immediately due and payable.  On April 18, 2006, Holdings entered into anagreement with UMB, the trustee for the bondholders, under which UMB agreed toforbear acceleration of Holdings’ guarantee obligations in exchange forHoldings delivering a letter of credit in the amount of $13.1 million to securethe payment of the obligations owed by Holdings to UMB (see Note 19).

 

Because Mesaba vacated the hangar in October2005 and Holdings is the guarantor of the facility, Holdings is currentlyseeking other sublessors to lease the facility. As of March 31, 2006, Holdings established a $4.8 million accrualrelated to this guaranty, which assumes that the facility will remain vacantfor the next two years, during which time Holdings will continue to make bondand lease payments, and that thereafter Holdings will be able to sublease thefacility at a 20% discount.  Holdingscontinues to search for sublessors of the facility and will reassess thisreserve in future periods as material developments occur.

 

*OtherGuarantees*

Mesaba has letters of credit to guaranteecertain obligations principally for workers’ compensation policies, airportleases and other obligations, which totaled $4.1 million and $3.4 million as ofMarch 31, 2006 and 2005, respectively. There were no amounts drawn on these letters of credit during fiscal2006, 2005 or 2004.  As collateral forthese letters of credit, Mesaba had $4.5 million and $3.6 million in cash heldin an investment account as of March 31, 2006 and 2005, respectively.  This amount is restricted and has beenclassified within “Long-term investments” in Mesaba’s condensed balance sheets.

 

InFebruary 2005, Big Sky obtained a revolving line of credit in the principalamount of $250,000 from First Interstate Bank of Billings.  In March 2006, the principal amount availableunder the line increased to $370,000. The line of credit charges a variable interest rate based on the primerate published in the *Wall Street Journal*.  At March 31, 2006, the rate was 7.75%.  The line of credit is collateralized by BigSky’s inventory, accounts receivable and equipment and is scheduled to maturein January 2007.

 

**15.****      ****Nonoperating Gain**

 

In April 2003, Congress enacted the EmergencyWartime Supplemental Appropriations Act. Among other items, the legislation included a $2.3 billion governmentgrant to United States airlines.  Inaccordance with this Act, for the fiscal year ended March 31, 2004, Mesabarecognized $2.3 million as “Other nonoperating income” and Big Sky recognized$0.3 million as “Other nonoperating income” and $0.2 million as a reduction of “Administrativeand other expense” in the accompanying consolidated statements of operations.

 

**16.****      ****Restatement**

 

Subsequent to the issuance of itsconsolidated financial statements for the year ended March 31, 2005 and thequarter ended June 30, 2005, the Company’s management determined that twocategories of pass-through costs under the ASA with Northwest were notpresented in accordance with Emerging Issues Task Force (“EITF”) No. 99-19, *Reporting Revenue Gross as a Principal vs. Net as an Agent*,and EITF No. 01-14, *Income StatementCharacterization of Reimbursements Received for ‘Out-of-Pocket’ ExpensesIncurred*.  First, the Companydetermined that certain landing fees reimbursed by Northwest had not beenrecognized in the Company’s consolidated statements of operations but shouldhave been recorded as both operating revenue and operating expense in priorperiods.  Second, the Company determinedthat aircraft fuel purchased from Northwest for the Saabs and CRJs should havebeen shown as a reduction of 

 

 

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revenue rather than as an operating expensein prior periods.  As a result of thesemisstatements, passenger revenues, aircraft fuel expense and landing feesexpense for fiscal 2005 and 2004 have been restated from amounts previouslyreported.  The restatement had no effecton previously reported operating income, income before income taxes, netincome, earnings per share, net cash flows or the Company’s financialcondition.

 

Asummary of the significant effects of this restatement on the Company’sconsolidated statements of operations for fiscal 2005 and 2004 is as follows,in thousands:

 
| ** **               | ** ** | **Year Ended  March 31, 2005** | ** ** | **Year Ended  March 31, 2004** | ** ** |
|--------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| ** **               | ** ** | **As Previously**              | ** ** | **As**                         | ** ** | **As Previously** | ** ** | **As** | ** ** |
| ** **               | ** ** | **Reported**                   | ** ** | **Restated**                   | ** ** | **Reported** | ** ** | **Restated** | ** ** |
| Passenger revenues       |       | $                              | 413,855    |                           | $          | 400,398 |   | $ | 417,300 |   | $ | 401,010 |   |
| Total operating revenues |       | 456,067                        |       | 442,610                        |       | 449,079 |   | 432,789 |   |
| Aircraft fuel            |       | 19,377                         |       | 2,471                          |       | 22,399 |   | 2,282 |   |
| Landing fees             |       | 6,759                          |       | 10,208                         |       | 7,108 |   | 10,935 |   |
| Total operating expenses |       | 447,428                        |       | 433,971                        |       | 445,053 |   | 428,763 |   |
|                          |            |                                |            |                                |            |  |  |  |  |  |  |  |  |

 

**17.****      ****Valuation and Qualifying Account**

 

The following is the activity within theCompany’s consolidated valuation and qualifying account for fiscal 2006, 2005and 2004, in thousands:

 
| ** **                       | ** ** | **Balances at** | ** ** | **Additions**  | ** ** | **Deductions** | ** ** | **Balances at** | ** ** |
|----------------------------------|------------|-----------------|------------|----------------|------------|----------------|------------|-----------------|------------|
| ** **                       | ** ** | **Beginning**   | ** ** | **Charged**    | ** ** | **from**       | ** ** | **End**         | ** ** |
| ** **                       | ** ** | **of Year**     | ** ** | **to Expense** | ** ** | **Reserve**    | ** ** | **of Year**     | ** ** |
| Allowance for doubtful accounts: |       |            |       |           |       |           |       |            |       |
| Year ended March 31, 2006        |       | $               | 601        |           | $          | 31,985         |       | $               | 32,553     | * | $ | 33 |   |
| Year ended March 31, 2005        |       | 926             |       | 694            |       | 1,019          |       | 601             |       |
| Year ended March 31, 2004        |       | 389             |       | 601            |       | 64             |       | 926             |       |
|                                  |            |                 |            |                |            |                |            |                 |            |  |  |  |  |

----

* $31.9 million of deductions was due to thedeconsolidation of Mesaba (see Note 1).

 

 

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**18.****      ****Quarterly Financial Data(Unaudited)**

 

The following is quarterly financial data forthe fiscal year ended March 31, 2006, in thousands, except per share data:

 

 
| ** **                                                                                  | ** ** | **Quarter Ended** | ** ** | ** **             | ** ** |
|---------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                                  | ** ** | **June 30, 2005** | ** ** | **September 30, 2005** | ** ** | **December 31, 2005(1)** | ** ** | **March 31, 2006(1)** | ** ** | **Fiscal  Year** | ** ** |
| ** **                                                                                  | ** ** | **As Previously** | ** ** | **As Restated —** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                  | ** ** | **Reported**      | ** ** | **see Note 16**        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Operating revenues                                                                          |       | $                 | 118,439    |                   | $          | 114,683 |   | $ | 114,906 |   | $ | 21,247 |   | $ | 5,443 |   | $ | 256,279 |   |
| Total operating expenses                                                                    |       | 119,357           |       | 115,601                |       | 155,132 |   | 28,307 |   | 19,940 |   | 318,980 |   |
| Operating income (loss)                                                                     |       | (918              | )          | (918                   | )          | (40,226 | ) | (7,060 | ) | (14,497 | ) | (62,701 | ) |
| Income (loss) before provision of income taxes and equity in loss of  Mesaba Aviation, Inc. |       | 1,878             |       | 1,878                  |       | (39,139 | ) | (6,393 | ) | (13,083 | ) | (56,737 | ) |
| Equity in Loss of Mesaba Aviation, Inc.                                                     |       | —            |       | —                 |       | — |   | (334 | ) | (39,619 | ) | (39,953 | ) |
| Net income (loss)                                                                           |       | 1,202             |       | 1,202                  |       | (25,504 | ) | (4,458 | ) | (54,088 | ) | (82,848 | ) |
| Earnings (loss) per common share:                                                           |       |              |       |                   |       |   |   |   |   |   |   |   |   |
| Basic                                                                                       |       | $                 | 0.06       |                   | $          | 0.06 |   | $ | (1.24 | ) | $ | (0.22 | ) | $ | (2.63 | ) | $ | (4.02)  (2 | ) |
| Diluted                                                                                     |       | $                 | 0.06       |                   | $          | 0.06 |   | $ | (1.24 | ) | $ | (0.22 | ) | $ | (2.63 | ) | $ | (4.02)  (2 | ) |
| Weighted average common shares outstanding:                                                 |       |              |       |                   |       |   |   |   |   |   |   |   |   |
| Basic                                                                                       |       | 20,574            |       | 20,574                 |       | 20,577 |   | 20,592 |   | 20,592 |   | 20,584 |   |
| Diluted                                                                                     |       | 21,194            |       | 21,194                 |       | 20,577 |   | 20,592 |   | 20,592 |   | 20,584 |   |

----

(1) As discussed in Note 1, Holdingsdeconsolidated Mesaba’s financial results under the equity method of accountingeffective October 13, 2005, the date of Mesaba’s bankruptcy filing.  As a result, Mesaba’s results of operationshave been removed from the Company’s consolidated results of operations sinceOctober 13, 2005.

 

(2) The sum of the earnings (loss) per sharefor each of the individual quarters does not equal earnings per share for thefiscal year due to rounding.

 

 

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The following is quarterly financial data forthe fiscal year ended March 31, 2005, in thousands, except per share data:

 
| ** **                                      | ** ** | **Quarter Ended** | ** ** | ** **             | ** ** | ** **            | ** ** |
|-------------------------------------------------|------------|-------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **June 30, 2004** | ** ** | **September 30, 2004** | ** ** | **December 31, 2004** | ** ** | **March 31, 2005** | ** ** | **Fiscal Year** | ** ** |
| ** **                                      | ** ** | **As Previously** | ** ** | **As Restated**        | ** ** | **As Previously**     | ** ** | **As Restated** | ** ** | **As Previously** | ** ** | **As Restated** | ** ** | **As Previously** | ** ** | **As Restated** | ** ** | **As Previously** | ** ** | **As Restated** | ** ** |
| ** **                                      | ** ** | **Reported**      | ** ** | **see Note 16**        | ** ** | **Reported**          | ** ** | **see Note 16** | ** ** | **Reported** | ** ** | **see Note 16** | ** ** | **Reported** | ** ** | **see Note 16** | ** ** | **Reported** | ** ** | **see Note 16** | ** ** |
| Operating revenues                              |       | $                 | 109,699    |                   | $          | 106,045               |       | $ | 118,113 |   | $ | 114,166 |   | $ | 115,512 |   | $ | 111,535 |   | $ | 112,743 |   | $ | 110,864 |   | $ | 456,067 |   | $ | 442,610 |   |
| Total operating expenses                        |       | 107,175           |       | 103,521                |       | 110,611               |       | 106,664 |   | 113,666 |   | 109,689 |   | 115,976 |   | 114,097 |   | 447,428 |   | 433,971 |   |
| Operating income (loss)                         |       | 2,524             |       | 2,524                  |       | 7,502                 |       | 7,502 |   | 1,846 |   | 1,846 |   | (3,233 | ) | (3,233 | ) | 8,639 |   | 8,639 |   |
| Income (loss) before provision for income taxes |       | 2,891             |       | 2,891                  |       | 8,034                 |       | 8,034 |   | 2,649 |   | 2,649 |   | (2,615 | ) | (2,615 | ) | 10,959 |   | 10,959 |   |
| Net income (loss)                               |       | 2,863             |       | 2,863                  |       | 4,737                 |       | 4,737 |   | 1,493 |   | 1,493 |   | (1,738 | ) | (1,738 | ) | 7,355 |   | 7,355 |   |
| Earnings (loss) per common share*:              |       |              |       |                   |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                           |       | $                 | 0.14       |                   | $          | 0.14                  |       | $ | 0.23 |   | $ | 0.23 |   | $ | 0.07 |   | $ | 0.07 |   | $ | (0.08 | ) | $ | (0.08 | ) | $ | 0.36 |   | $ | 0.36 |   |
| Diluted                                         |       | $                 | 0.14       |                   | $          | 0.14                  |       | $ | 0.23 |   | $ | 0.23 |   | $ | 0.07 |   | $ | 0.07 |   | $ | (0.08 | ) | $ | (0.08 | ) | $ | 0.35 |   | $ | 0.35 |   |
| Weighted average common shares outstanding:     |       |              |       |                   |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                           |       | 20,452            |       | 20,452                 |       | 20,471                |       | 20,471 |   | 20,524 |   | 20,524 |   | 20,574 |   | 20,574 |   | 20,505 |   | 20,505 |   |
| Diluted                                         |       | 20,976            |       | 20,976                 |       | 20,947                |       | 20,947 |   | 21,123 |   | 21,123 |   | 20,574 |   | 20,574 |   | 21,050 |   | 21,050 |   |

----

* The sum of the earnings (loss) per share foreach of the individual quarters does not equal earnings per share for thefiscal year due to rounding.

 

 

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**19.****      ****Subsequent Events**

 

*Letter ofCredit*

In connection with Holdings’ guaranty relatedto Mesaba’s facility at the Cincinnati/Northern Kentucky International Airport,Holdings entered into an agreement on April 18, 2006, with UMB, the trustee forthe bondholders, under which UMB agreed to forbear acceleration of Holdings’guaranty obligations in exchange for Holdings delivering a letter of credit inthe amount of $13.1 million to secure the payment of the obligations owed byHoldings to UMB.

 

The letter of credit was issued by FirstInterstate Bank of Billings and is currently fully collateralized by Holdings’cash account held at First Interstate Bank.  Under the Agreement with UMB,Holdings is obligated to maintain the letter of credit until all obligationsunder the bonds are satisfied.  Holdings’ annual obligations with respectto the bonds and the ground lease for the facility total approximately $1.2million, and those obligations will continue through July 2029 and willincrease at scheduled intervals in accordance with the terms of the bonddocuments.  The UMB agreement and the letter of credit provide that theamount of the letter of credit will automatically decrease each July inaccordance with the redemption schedule for the bonds.

 

UMB may draw on the letter of credit upon theoccurrence of an event of default under its agreement with Holdings, includingif Holdings fails to make any payment when due to UMB, if Holdings fails toprovide evidence that the letter of credit has been renewed annually (or ifHoldings fails to renew the letter of credit), if UMB receives notice fromFirst Interstate Bank of the bank’s intent not to renew the letter of credit,if the bonds become subject to mandatory redemption, if Holdings fails tocomply with the terms of its agreement with UMB or if Holdings commits anyevent of default under its guaranty of Mesaba’s bond obligations. Holdings recorded the cash supporting the letter of credit as restricted cashon the Company’s consolidated balance sheet effective April 18, 2006.

 

**20.****      ****Financial Information of Mesaba**

The following condensed financial statements of Mesaba have been prepared inconformity with SOP 90-7, which requires that the liabilities subject tocompromise by the Bankruptcy Court be segregated from liabilities not subjectto compromise, and that all transactions directly associated with thereorganization be identified. Liabilities subject to compromise include prepetition unsecured claimsthat may be settled at amounts that differ from those recorded in Mesaba’scondensed financial statements.

 

The financial information is also prepared ona going concern basis, which contemplates the realization of assets and theliquidation of liabilities in the ordinary course of business.  However, as a result of the bankruptcyfiling, such realization of assets and liquidation of liabilities is subject tosignificant uncertainty.

 

As discussed in Note 1, Holdings hasdeconsolidated Mesaba, its wholly-owned subsidiary, from the Company’s March31, 2006 consolidated balance sheet and the consolidated statement ofoperations and cash flows since Mesaba’s bankruptcy filing on October 13, 2005through March 31, 2006.  Holdings’investment in Mesaba is accounted for and reported on the equity method ofaccounting subsequent to the October 13, 2005 deconsolidation date as requiredby generally accepted accounting principles and Securities and ExchangeCommission guidance.  All of Holdings’previously reported consolidated balance sheets, statements of operations andcash flows prior to October 13, 2005 continue to include Mesaba’s financialposition, results of operations and cash flows.

 

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**MESABAAVIATION, INC.**

**(Debtor-in-Possession)**

**CondensedBalance Sheets**

**As ofMarch 31, 2006 and 2005**

**(inthousands)**

 
| ** **                                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------|------------|----------|------------|----------|------------|
| ASSETS                                                   |       |     |       |     |       |
| CURRENT ASSETS:                                          |       |     |       |     |       |
| Cash and cash equivalents                                |       | $        | 20,718     |     | $          | 20,357 |   |
| Short-term investments                                   |       | 3,262    |       | —   |       |
| Restricted cash                                          |       | 6,782    |       | —   |       |
| Accounts receivable, net of reserves of $29,755 and $568 |       | 32,469   |       | 29,163   |       |
| Inventories, net                                         |       | 9,001    |       | 10,329   |       |
| Prepaid expenses and deposits                            |       | 5,998    |       | 4,777    |       |
| Deferred income taxes and other                          |       | —   |       | 11,246   |       |
| Intercompany receivable from Holdings                    |       | 54       |       | 54       |       |
| Total current assets                                     |       | 78,284   |       | 75,926   |       |
|                                                     |       |     |       |     |       |
| PROPERTY AND EQUIPMENT, net                              |       | 32,532   |       | 36,585   |       |
|                                                     |       |     |       |     |       |
| NONCURRENT ASSETS:                                       |       |     |       |     |       |
| Long-term investments                                    |       | 6,761    |       | 3,615    |       |
| Other assets, net                                        |       | 864      |       | 4,751    |       |
|                                                     |       | $        | 118,441    |     | $          | 120,877 |   |
|                                                     |       |     |       |     |       |
| LIABILITIES AND  SHAREHOLDER’S EQUITY               |       |     |       |     |       |
|                                                     |       |     |       |     |       |
| CURRENT LIABILITIES                                      |       |     |       |     |       |
| Accounts payable                                         |       | $        | 8,638      |     | $          | 17,422 |   |
| Accrued liabilities:                                     |       |     |       |     |       |
| Payroll                                                  |       | 14,666   |       | 18,190   |       |
| Maintenance                                              |       | 17,250   |       | 20,082   |       |
| Deferred income                                          |       | 2,962    |       | 2,340    |       |
| Other current liabilities                                |       | 9,468    |       | 15,546   |       |
| Total current liabilities                                |       | 52,984   |       | 73,580   |       |
|                                                     |       |     |       |     |       |
| OTHER NONCURRENT LIABILITIES                             |       | 2,547    |       | 5,367    |       |
| Total liabilities not subject to compromise              |       | 55,531   |       | 78,947   |       |
|                                                     |       |     |       |     |       |
| LIABILITIES SUBJECT TO COMPROMISE (A)                    |       | 59,973   |       | —   |       |
| Total liabilities                                        |       | 115,504  |       | 78,947   |       |
|                                                     |       |     |       |     |       |
| COMMITMENTS AND CONTINGENCIES (Note 14)                  |       |     |       |     |       |
|                                                     |       |     |       |     |       |
| SHAREHOLDER’S EQUITY:                               |       |     |       |     |       |
| Paid-in capital                                          |       | 48,255   |       | 16,501   |       |
| Accumulated other comprehensive loss                     |       | (13      | )          | —   |       |
| Retained earnings                                        |       | (45,305  | )          | 25,429   |       |
| Total shareholder’s equity                          |       | 2,937    |       | 41,930   |       |
|                                                     |       | $        | 118,441    |     | $          | 120,877 |   |

 

 

88

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**MESABAAVIATION, INC.**

**(Debtor-in-Possession)**

**CondensedStatements of Operations**

**YearsEnded March 31, 2006, 2005 and 2004**

**(inthousands)**

 
| ** **                         | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| OPERATING REVENUES:                |       |     |       |     |       |     |       |
| Passenger                          |       | $        | 373,031    |     | $          | 392,808  |       | $ | 391,698 |   |
| Freight and other                  |       | 35,783   |       | 34,725   |       | 24,620   |       |
| Total operating revenues           |       | 408,814  |       | 427,533  |       | 416,318  |       |
|                               |       |     |       |     |       |     |       |
| OPERATING EXPENSES:                |       |     |       |     |       |     |       |
| Wages and benefits                 |       | 145,495  |       | 140,871  |       | 133,454  |       |
| Aircraft maintenance               |       | 83,368   |       | 81,860   |       | 77,381   |       |
| Aircraft rents                     |       | 92,948   |       | 100,502  |       | 103,011  |       |
| Landing fees                       |       | 9,333    |       | 9,959    |       | 10,603   |       |
| Insurance and taxes                |       | 6,346    |       | 6,156    |       | 8,366    |       |
| Depreciation and amortization      |       | 12,243   |       | 13,844   |       | 16,299   |       |
| Administrative and other           |       | 68,000   |       | 59,885   |       | 57,048   |       |
| Impairment and other charges (C)   |       | 31,206   |       | —   |       | —   |       |
| Total operating expenses           |       | 448,939  |       | 413,077  |       | 406,162  |       |
| Operating (loss) income            |       | (40,125  | )          | 14,456   |       | 10,156   |       |
|                               |       |     |       |     |       |     |       |
| NONOPERATING INCOME (EXPENSE):     |       |     |       |     |       |     |       |
| Interest income and other          |       | 1,194    |       | 259      |       | 2,483    |       |
| Reorganization items, net (B)      |       | (23,395  | )          | —   |       | —   |       |
| Nonoperating income (expense), net |       | (22,201  | )          | 259      |       | 2,483    |       |
| (Loss) income before income taxes  |       | (62,326  | )          | 14,715   |       | 12,639   |       |
|                               |       |     |       |     |       |     |       |
| PROVISION FOR INCOME TAXES         |       | (8,408   | )          | (6,611   | )          | (6,497   | )          |
| NET (LOSS) INCOME                  |       | $        | (70,734    | )        | $          | 8,104    |       | $ | 6,142 |   |

 

 

89

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**MESABAAVIATION, INC.**

**(Debtor-in-Possession)**

**CondensedStatements of Cash Flows**

**YearsEnded March 31, 2006, 2005 and 2004**

**(inthousands)**

 
| ** **                                                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                   |       |     |       |     |       |     |       |
| Net (loss) income                                                                                       |       | $        | (70,734    | )        | $          | 8,104    |       | $ | 6,142 |   |
| Adjustments to reconcile net (loss) income to net cash provided by  (used in) operating activities:     |       |     |       |     |       |     |       |
| Depreciation and amortization                                                                           |       | 12,243   |       | 13,844   |       | 16,299   |       |
| Amortization of investment discounts                                                                    |       | 44       |       | —   |       | —   |       |
| Amortization of deferred credits                                                                        |       | (1,968   | )          | (1,395   | )          | (2,092   | )          |
| Loss on disposition of assets                                                                           |       | 63       |       | 133      |       | 33       |       |
| Deferred income taxes                                                                                   |       | 11,246   |       | 679      |       | (100     | )          |
| Impairment and other charges                                                                            |       | 31,206   |       | —   |       | —   |       |
| Changes in current operating items:                                                                     |       |     |       |     |       |     |       |
| Accounts receivable                                                                                     |       | (32,310  | )          | (1,665   | )          | 12,230   |       |
| Inventories                                                                                             |       | 1,328    |       | (2,483   | )          | (703     | )          |
| Prepaid expenses and deposits                                                                           |       | (1,221   | )          | (1,826   | )          | (146     | )          |
| Accounts payable and other                                                                              |       | 47,180   |       | 7,135    |       | 11,222   |       |
| Net cash (used in) provided by operating activities before  reorganization items                        |       | (2,923   | )          | 22,526   |       | 42,885   |       |
|                                                                                                    |       |     |       |     |       |     |       |
| CASH FLOWS FROM REORGANIZATION ACTIVITIES:                                                              |       |     |       |     |       |     |       |
| Reorganization items, net                                                                               |       | (23,395  | )          | —   |       | —   |       |
| Increase in damage claims                                                                               |       | 20,066   |       | —   |       | —   |       |
| Impairment of property and equipment                                                                    |       | 528      |       | —   |       | —   |       |
| Reversal of accrued maintenance                                                                         |       | (4,239   | )          | —   |       | —   |       |
| Net cash (used in) reorganization activities                                                            |       | (7,040   | )          | —   |       | —   |       |
| Net cash (used in) provided by operating activities                                                     |       | (9,963   | )          | 22,526   |       | 42,885   |       |
|                                                                                                    |       |     |       |     |       |     |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                   |       |     |       |     |       |     |       |
| Purchases of investments                                                                                |       | (8,529   | )          | (1,589   | )          | (26      | )          |
| Sales of investments                                                                                    |       | 11,543   |       | —   |       | —   |       |
| Increase in restricted cash                                                                             |       | (6,782   | )          | —   |       | —   |       |
| Purchases of property and equipment                                                                     |       | (8,101   | )          | (9,390   | )          | (10,661  | )          |
| Net cash used in investing activities                                                                   |       | (11,869  | )          | (10,979  | )          | (10,687  | )          |
|                                                                                                    |       |     |       |     |       |     |       |
| CASH FLOWS FROM FINANCING ACTIVITIES                                                                    |       |     |       |     |       |     |       |
| Capital contribution from MAIR Holdings, Inc.                                                           |       | 22,193   |       | —   |       | 2,799    |       |
| Dividends paid to MAIR Holdings, Inc.                                                                   |       | —   |       | (18,000  | )          | (10,000  | )          |
| Net cash provided by (used in) financing activities                                                     |       | 22,193   |       | (18,000  | )          | (7,201   | )          |
|                                                                                                    |       |     |       |     |       |     |       |
| NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                                                    |       | 361      |       | (6,453   | )          | 24,997   |       |
|                                                                                                    |       |     |       |     |       |     |       |
| CASH AND CASH EQUIVALENTS:                                                                              |       |     |       |     |       |     |       |
| Beginning of period, excluding restricted cash and cash equivalents                                     |       | 20,357   |       | 26,810   |       | 1,813    |       |
| End of period, excluding restricted cash and cash equivalents                                           |       | $        | 20,718     |     | $          | 20,357   |       | $ | 26,810 |   |
|                                                                                                    |       |     |       |     |       |     |       |
| SUPPLEMENTAL CASH FLOW INFORMATION:                                                                     |       |     |       |     |       |     |       |
| (Refund received) cash paid during period for:                                                          |       |     |       |     |       |     |       |
| Interest                                                                                                |       | $        | —     |     | $          | —   |       | $ | — |   |
| Income taxes                                                                                            |       | (866     | )          | 53       |       | 853      |       |
|                                                                                                    |       |     |       |     |       |     |       |
| SUPPLEMENTAL NON CASH FINANCING ACTIVITY:                                                               |       |     |       |     |       |     |       |
| Capital contribution through transfer of short-term and long-term  investments from MAIR Holdings, Inc. |       | 9,562    |       | —   |       | —   |       |

 

 

90

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The following table presents Mesaba’scondensed results of operations for the period April 1, 2005 to October 13,2005 (the date of Mesaba’s Chapter 11 bankruptcy filing) which are included inMesaba’s results of operations for the year ended March 31, 2006 above andwithin the Company’s consolidated results of operations prior todeconsolidation:

 
| Operating revenues                     |   | $       | 235,763 |   |
|----------------------------------------|--------|---------|---------|--------|
| Operating expenses                     |   | 272,778 |    |
| Operating loss                         |   | (37,015 | )       |
| Other non operating income             |   | 474     |    |
| Loss before provision for income taxes |   | (36,541 | )       |
| Benefit for income taxes               |   | 11,732  |    |
| Net loss                               |   | $       | (24,809 | )      |

 

**Notesto Condensed Financial Statements**

 

(A)

Liabilities subject to compromise in Mesaba’scondensed balance sheet at March 31, 2006 refers to both secured and unsecuredobligations that will be accounted for under a plan of reorganization,including claims incurred prior to the petition date.  They represent the estimated amount expectedto be allowed on known or potential claims to be resolved through the Chapter11 bankruptcy process and remain subject to future adjustments arising fromnegotiated settlements, actions of the Bankruptcy Court, rejection of executorycontracts and unexpired leases, the determination as to the value of anycollateral securing claims, proofs of claim or other events.

 

Mesaba has endeavored to notify all of itsknown or potential creditors whose claims are subject to Mesaba’s Chapter 11case.  Subject to certain exceptionsunder the Bankruptcy Code, Mesaba’s Chapter 11 filing automatically stayed thecontinuation of any judicial or administrative proceedings or other actionsagainst Mesaba or its property to recover on, collect or secure a claim arisingprior to the Petition Date.  The Bar Datefor creditors to file proofs of claim against Mesaba was April 11, 2006 forgovernmental entities and February 28, 2006 for all other creditors.  A proof of claim arising from the rejectionof an executory contract or an expired lease must be filed by the later of theBar Date or thirty days from the effective date of any authorized rejection.

 

Although Mesaba has estimated the value ofthe claims that will be allowed by the Bankruptcy Court at $60.0 million, theBankruptcy Court will make the final determination regarding what portion ofthe $216.8 million in total proofs of claim filed will be deemed allowableclaims.  The determination of how thoseliabilities will ultimately be treated will not be known until the Bankruptcy Courtapproves a plan of reorganization and the claims resolution process iscomplete, which may occur well after a confirmation of a plan ofreorganization.  Mesaba will continue toevaluate the amounts of these liabilities through the remainder of the Chapter11 process.  Mesaba will continue torecognize any additional amounts subject to compromise that it identifies inthe future.  As a result, the amounts ofliabilities subject to compromise are likely to change.

 

 

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Liabilitiessubject to compromise at March 31, 2006 were as follows, in thousands:

 

 
| Accounts payable and other liabilities |   | $      | 34,936 |   |
|----------------------------------------|--------|--------|--------|--------|
| Damage claims                          |   | 20,066 |   |
| Secured claims                         |   | 2,520  |   |
| Priority tax claims                    |   | 2,451  |   |
|                                   |   | $      | 59,973 |   |

 

(B)

Reorganization items recorded from thePetition Date through March 31, 2006 consisted of transactions and events thatwere directly associated with the reorganization of Mesaba.  The reorganization activity included aircraftimpairment and other rejection charges, legal and professional fees to supportthe restructuring process and the write-off of maintenance accruals.  The charge for damage claims results fromestimated claims as a result of Mesaba’s rejection or renegotiation of certainaircraft and other leases and obligations as part of the bankruptcy process.

 

Net reorganization items for the year endedMarch 31, 2006 were as follows, in thousands:

 

 
| Damage claims                        |   | $      | 20,066 |   |
|--------------------------------------|--------|--------|--------|--------|
| Legal and professional fees          |   | 6,896  |   |
| Impairment of property and equipment |   | 528    |   |
| Other expenses                       |   | 144    |   |
| Reversal of accrued maintenance      |   | (4,239 | )      |
|                                 |   | $      | 23,395 |   |

 

(C)

Impairmentcharges of $31.2 million were recorded in fiscal 2006 as a result of the $29.1million charge to establish a reserve on the unsecured prepetition receivablesdue from Northwest (net of certain offsetting liabilities) (see Notes 3 and 5),and the $2.1 million write-off of the warrants related to the prior airlineservices agreements (see Note 2).

 

 

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**21.****      ****Supplemental Cash FlowInformation**

 

Thefollowing tables present supplementary cash flow information and non-cashactivity for the years ended March 31, in thousands:

 
| ** **                                         | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| SUPPLEMENTARY  CASH FLOW INFORMATION:              |       |       |       |       |       |       |       |
| Cash paid (refund received) during the year for:   |       |       |       |       |       |       |       |
| Interest                                           |       | $          | 76         |       | $          | 61         |       | $ | 83 |   |
| Income taxes                                       |       | (1,735     | )          | 5,073      |       | 2,850      |       |
|                                               |       |       |       |       |       |       |       |
|                                               |       |       |       |       |       |       |       |
|                                               |       |       |       |       |       |       |       |
| ** **                                         | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** |
| SUPPLEMENTAL NON-CASH ACTIVITY:                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Effect of deconsolidation of Mesaba Aviation, Inc: |       |       |       |       |       |       |       |
| Short-term investments                             |       | $          | 2,799      |       | —     |       | —     |   |
| Restricted cash and cash equivalents               |       | 6,921      |       | —     |       | —     |       |
| Accounts receivable, net                           |       | 31,817     |       | —     |       | —     |       |
| Inventories, net                                   |       | 11,236     |       | —     |       | —     |       |
| Prepaid expenses and deposits                      |       | 5,476      |       | —     |       | —     |       |
| Deferred income taxes and other                    |       | 22,446     |       | —     |       | —     |       |
| Property and equipment, net                        |       | 35,608     |       | —     |       | —     |       |
| Long-term investments and other                    |       | 11,587     |       | —     |       | —     |       |
| Accounts payable and accrued liabilities           |       | (87,560    | )          | —     |       | —     |       |
| Other noncurrent liabilities                       |       | (3,936     | )          | —     |       | —     |       |
|                                                    |            |            |            |            |            |            |            |  |  |  |

 

## ***Item9.  CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE***

 

None.

## ***Item9A.  CONTROLS AND PROCEDURES***

 

*Evaluationof Disclosure Controls and Procedures*

As of March 31, 2006, the Company conductedan evaluation under the supervision and with the participation of the Company’smanagement, including the Company’s Chief Executive Officer and Chief FinancialOfficer, regarding the effectiveness of the design and operation of the Company’sdisclosure controls and procedures pursuant to Rule 13a-15(b) of the SecuritiesExchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief Executive Officer and ChiefFinancial Officer concluded that the Company’s disclosure controls andprocedures were effective as of the date of such evaluation.

 

*Management’sReport on Internal Control Over Financial Reporting*

The Company’s management is responsible forestablishing and maintaining adequate internal control over financialreporting, as such term is defined in Exchange Act Rule 13a-15(f).  Because of its inherent 

 

 

93

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limitations, internal control over financialreporting may not prevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to risk that controls may becomeinadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.  Under the supervision and with theparticipation of management, including the Chief Executive Officer and theChief Financial Officer, an evaluation was conducted of the effectiveness ofthe internal control over financial reporting based on criteria established in *Internal Control — Integrated Framework* issued by theCommittee of Sponsoring Organizations of the Treadway Commission.  Management concluded that the Companymaintained effective internal control over financial reporting as of March 31,2006.  Management’s assessment of theeffectiveness of internal control over financial reporting as of March 31, 2006has been audited by Deloitte & Touche LLP, an independent registered publicaccounting firm, as stated in their report below.

 

*Changesin Internal Controls*

During the fourth quarter of fiscal 2006,there were no changes in internal control over financial reporting that had amaterial effect on internal control over financial reporting or were reasonablylikely to have a material effect on internal control over financial reporting.

 

*Reportof Independent Registered Public Accounting Firm on Internal Control OverFinancial Reporting*

 

Tothe Board of Directors and Shareholders

MAIRHoldings, Inc.

Minneapolis,Minnesota

 

We have audited management’s assessment,included in the accompanying Management’s Report on Internal Control OverFinancial Reporting, that MAIR Holdings, Inc. and subsidiaries (the “Company”)maintained effective internal control over financial reporting as of March 31,2006, based on criteria established in *Internal Control —Integrated Framework* issued by the Committee of Sponsoring Organizationsof the Treadway Commission.  The Company’smanagement is responsible for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting.  Ourresponsibility is to express an opinion on management’s assessment and anopinion on the effectiveness of the Company’s internal control over financialreporting based on our audit.

 

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in all materialrespects.  Our audit included obtainingan understanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

 

A company’s internal control over financialreporting is a process designed by, or under the supervision of, the company’sprincipal executive and principal financial officers, or persons performingsimilar functions, and effected by the company’s board of directors,management, and other personnel to provide reasonable assurance regarding thereliability of financial reporting and the preparation of financial statementsfor external purposes in accordance with generally accepted accountingprinciples.  A company’s internal controlover financial reporting includes those policies and procedures that (1)pertain to the maintenance of records that, in reasonable detail, accuratelyand fairly reflect the transactions and dispositions of the assets of thecompany; (2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures ofthe company are being made only in 

 

 

94

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accordance with authorizations of managementand directors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Because of the inherent limitations ofinternal control over financial reporting, including the possibility ofcollusion or improper management override of controls, material misstatementsdue to error or fraud may not be prevented or detected on a timely basis.  Also, projections of any evaluation of theeffectiveness of the internal control over financial reporting to futureperiods are subject to the risk that the controls may become inadequate becauseof changes in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

 

In our opinion, management’s assessment thatthe Company maintained effective internal control over financial reporting asof March 31, 2006, is fairly stated, in all material respects, based on thecriteria established in *Internal Control —Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission. Also, in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of March 31, 2006, basedon the criteria established in *Internal Control —Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission.

 

We have also audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets as of March 31, 2006 and 2005, and the relatedconsolidated statements of operations, shareholders’ equity and cash flows foreach of the three years in the period ended March 31, 2006 of the Company andour report dated June 22, 2006 expressed an unqualified opinion on thosefinancial statements and included an explanatory paragraph related to thedeconsolidation and reorganization under Chapter 11 of the United StatesBankruptcy Code of Mesaba Aviation, Inc. (Debtor-in-Possession), a wholly-ownedsubsidiary of the Company.

 

DELOITTE & TOUCHE LLP

 

Minneapolis, Minnesota

June 22, 2006

## ***Item9B.  OTHER INFORMATION***

 

None.

 

# **PART III**

## ***Item10.  DIRECTORS AND EXECUTIVE OFFICERS OFTHE REGISTRANT***

 

Information regarding the directors andexecutive officers of the Company is incorporated herein by reference to thedescriptions set forth under the caption “Election of Directors” in the ProxyStatement to be issued in connection with the 2006 Annual Meeting ofShareholders (the “2006 Proxy Statement”).

## ***Item11.  EXECUTIVE COMPENSATION***

 

Information regarding executive compensationis incorporated herein by reference to the information set forth under thecaption “Compensation of Executive Officers” in the 2006 Proxy Statement.

 

 

95

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## ***Item12.  SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS***

 

Information regarding security ownership ofcertain beneficial owners and management of the Company is incorporated hereinby reference to the information set forth under the caption “Security Ownershipof certain Beneficial Owners and Management” in the 2006 Proxy Statement.

## ***Item13.  CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS***

 

Information regarding certain relationshipsand related transactions with the Company is incorporated herein by referenceto the information set forth under the caption “Certain Transactions” in the2006 Proxy Statement.

## ***Item14.  PRINCIPAL ACCOUNTANT FEES ANDSERVICES***

 

Information regarding principal accountantfees and services is incorporated herein by reference to the information setforth under the caption “Ratification and Selection of Independent RegisteredPublic Accounting Firm” in the 2006 Proxy Statement.

# **PART IV**

## ***Item15.  EXHIBITS AND FINANCIAL STATEMENTSCHEDULES***

 

**(a)(1)Financial Statements**

Included in Item 8 of Part II of this AnnualReport on Form 10-K are the following: Report of Independent Registered Public Accounting Firm, ConsolidatedBalance Sheets, Consolidated Statements of Operations, Consolidated Statementsof Shareholders’ Equity, Consolidated Statements of Cash Flows and Notes toConsolidated Financial Statements. Included in Item 9A of Part II of this Annual Report on Form 10-K isManagement’s Report on Internal Control Over Financial Reporting and Report ofIndependent Registered Public Accounting Firm on Internal Control OverFinancial Reporting.

 

**(a)(2)  Financial Statement Schedules**

The information required in Schedule II isincluded in Item 8 of Part II of this Annual Report on Form 10-K.

 

**(a)(3)  Exhibits**

The Exhibits filed or incorporated byreference herewith are as specified in the Exhibit Index.

 

 

96

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# **SIGNATURES**

 

Pursuant to the requirements of Section 13 or15(d) of the Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
| ** **           | **MAIR HOLDINGS, INC.** |
|----------------------|-------------------------|
|                 |                    |
| Dated: June 27, 2006 | By:                     | /s/ PAUL F. FOLEY |
|                 |                    | Paul F. Foley |
|                 |                    | President and Chief  Executive Officer |

 

Each of the undersigned directors andofficers of MAIR Holdings, Inc. whose signature appears below herebyconstitutes and appoints Paul F. Foley and Ruth M. Timm, or either of them,with power to act one without the other, his or her true and lawfulattorney-in-fact and agent, with full power of substitution and resubstitution,for such individual and in such individual’s name, place and stead, in any andall capacities, to act on, sign and file with the Securities and ExchangeCommission this Annual Report on Form 10-k, to be filed pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934, as amended, including anyamendment or amendments to such report, together with all exhibits andschedules thereto, granting unto said attorney-in-fact and agent, full powerand authority to do and perform each and every act and thing necessary oradvisable to be done in connection therewith, as fully to all intents andpurposes as he or she might or could do in person, hereby ratifying andconfirming all that said attorney-in-fact and agent, or his or her substituteor substitutes, may lawfully do or cause to be done by virtue hereof.

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the registrant and in the capacities and on thedates indicated.

 
| /s/ PAUL F. FOLEY        |   | President and Chief  Executive Officer                 | June 27, 2006 |
|--------------------------|--------|--------------------------------------------------------|---------------|
| Paul F. Foley            |   | (Principal Executive  Officer) and Director            |          |
|                     |   |                                                   |          |
| /s/ ROBERT E. WEIL       |   | Vice President, Chief  Financial Officer and Treasurer | June 27, 2006 |
| Robert E. Weil           |   | (Principal Financial  Officer)                         |          |
|                     |   |                                                   |          |
| /s/ DONALD E. BENSON     |   | Director                                               | June 27, 2006 |
| Donald E. Benson         |   |                                                   |          |
|                     |   |                                                   |          |
| /s/ PIERSON M. GRIEVE    |   | Director                                               | June 27, 2006 |
| Pierson M. Grieve        |   |                                                   |          |
|                     |   |                                                   |          |
| /s/ JAMES A. LEE         |   | Director                                               | June 27, 2006 |
| James A. Lee             |   |                                                   |          |
|                     |   |                                                   |          |
| /s/ CARL R. POHLAD       |   | Director                                               | June 27, 2006 |
| Carl R. Pohlad           |   |                                                   |          |
|                     |   |                                                   |          |
| /s/ ROBERT C. POHLAD     |   | Director                                               | June 27, 2006 |
| Robert C. Pohlad         |   |                                                   |          |
|                     |   |                                                   |          |
| /s/ RAYMOND W. ZEHR, JR. |   | Director                                               | June 27, 2006 |
| Raymond W. Zehr, Jr.     |   |                                                   |          |

 

 

97

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# **EXHIBIT INDEX**

 
| **Exhibit********Number** | ** ** | **Document Description**                                                                                                                                                                                                                                                                                                                                                 |
|---------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                      |       |                                                                                                                                                                                                                                                                                                                                                                     |
| 3.1                       |       | Amended  and Restated Articles of Incorporation. Incorporated by reference to Exhibit  4.1 to the Company’s Form 8-K filed August 27, 2003.                                                                                                                                                                                                                         |
| 3.2                       |       | Bylaws.  Incorporated by reference to the Company’s Form 10-K filed June 14, 2005.                                                                                                                                                                                                                                                                                  |
| 4.1                       |       | Specimen  certificate for shares of the Common Stock of the Company. Incorporated by  reference to Exhibit 4.2 to the Company’s Form 8-K filed August 27, 2003.                                                                                                                                                                                                     |
| 4.2                       |       | Amended  and Restated Warrant dated August 29, 2005 issued to Northwest Airlines, Inc.  Incorporated by reference to Exhibit 4.2 to the Company’s Form 10-Q for the  quarter ended September 30, 2005.                                                                                                                                                              |
| 4.3                       |       | Registration  Rights Agreement dated as of August 29, 2005 among MAIR Holdings, Inc.,  Northwest Airlines, Inc., Boeing Capital Corporation and U.S. Bank National  Association. Incorporated by reference to Exhibit 4.3 to the Company’s Form  10-Q for the quarter ended September 30, 2005.                                                                     |
| 10.1                      |       | 1994  Stock Option Plan. Incorporated by reference to Exhibit 10.1 to the Company’s  Form 10-K for the fiscal year ended March 31, 2005.                                                                                                                                                                                                                            |
| 10.2                      |       | 1996  Directors’ Option Plan. Incorporated by reference to Exhibit 10.2 to the  Company’s Form 10-K for the fiscal year ended March 31, 2005.                                                                                                                                                                                                                  |
| 10.3                      |       | 2000  Stock Incentive Plan. Incorporated by reference to Exhibit 10.3 to the  Company’s Form 10-K for the fiscal year ended March 31, 2005.                                                                                                                                                                                                                         |
| 10.4                      |       | Mesaba  Aviation 2003 Incentive Award Plan. Incorporated by reference to Exhibit 10.4  to the Company’s Form 10-K for the fiscal year ended March 31, 2005.                                                                                                                                                                                                         |
| 10.5                      |       | Airline  Services Agreement dated as of August 29, 2005 between Mesaba Aviation, Inc.  and Northwest Airlines, Inc. (certain portions of this document have been  deleted pursuant to an application for confidential treatment under Rule  24b-2). Incorporated by reference to Exhibit 10.5 to the Company’s Form 10-Q  for the quarter ended September 30, 2005. |
| 10.6                      |       | Agreement  dated as of August 29, 2005 between MAIR Holdings, Inc. and Northwest  Airlines, Inc. (certain portions of this document have been deleted pursuant  to an application for confidential treatment under Rule 24b-2). Incorporated  by reference to Exhibit 10.5 to the Company’s Form 10-Q for the quarter ended  September 30, 2005.                    |
| 10.7                      |       | Special  Facilities Lease dated as of June 1, 1990 between Charter County of Wayne,  State of Michigan and Mesaba Aviation, Inc. Incorporated by reference to  Exhibit 10.7 to the Company’s Form 10-Q for the quarter ended September 30,  2005.                                                                                                                   |
| 10.8                      |       | Ground  Lease dated May 18, 1990 between Charter County of Wayne, State of Michigan  and Mesaba Aviation, Inc. Incorporated by reference to Exhibit 10.8 to the  Company’s Form 10-Q for the quarter ended September 30, 2005.                                                                                                                                      |
| 10.9                      |       | Stock  Purchase Agreement between the Company and Carl R. Pohlad dated as of October  18, 1993. Incorporated by reference to Exhibit 10.10 to the Company’s Form  10-K for the fiscal year ended March 31, 2005.                                                                                                                                                    |
| 10.10                     |       | Term  Sheet Proposal for the Acquisition of Saab 340 Aircraft by Mesaba Aviation,  Inc. dated March 7, 1996 (certain portions of this document have been deleted  pursuant to an application for confidential treatment under Rule 24b-2).  Incorporated by reference to Exhibit 10U to the Company’s Form 10-K/A for the  fiscal year ended March 31, 1996.        |
| 10.11                     |       | Letter  Agreement regarding Saab 340B Plus Acquisition Financing dated March 7, 1996  ((certain portions of this document have been deleted pursuant to an  application for confidential treatment under Rule 24b-2). Incorporated by  reference to Exhibit 10V to the Company’s Form 10-K/A for the fiscal year  ended March 31, 1996.                             |
| 10.12                     |       | Lease  Agreement, dated as of July 1, 1999, between Kenton County Airport Board and  Mesaba Aviation, Inc. Incorporated by reference to Exhibit 10AA to the  company’s Form 10-K for the fiscal year ended March 31, 2000.                                                                                                                                          |
| 10.13                     |       | Ground  Lease, dated as of September 1, 1999, between Kenton County Airport Board and  Mesaba Aviation, Inc. Incorporated by reference to Exhibit 10BB to the Company’s  Form 10-K for the fiscal year ended March 31, 2000.                                                                                                                                        |
| 10.14                     |       | Aircraft  Hangar Facility Lease Agreement between Metropolitan Airports Commission  Minneapolis — St. Paul and Mesaba Aviation, Inc. dated September 30, 2002.  Incorporated by reference to Exhibit 10Y to the Company’s Form 10-Q for the  quarter ended June 30, 2003.                                                                                      |
| 10.15                     |       | Lease  between Spectrum Investment Group, L.L.C. and Mesaba Aviation, Inc. entered  into as of April 25, 2003. Incorporated by reference to Exhibit 10Z to the  Company’s Form 10-Q for the quarter ended June 30, 2003.                                                                                                                                            |
| 10.16                     |       | Management  Compensation Agreement between the Company and Paul F. Foley, dated October  1, 2004. Incorporated by reference to Exhibit 10.1 to the Company’s Current  Report on Form 8-K filed on October 22, 2004.                                                                                                                                                 |
| 10.17                     |       | Agreement,  dated April 18, 2006, between MAIR Holdings, Inc. and UMB Bank, N.A. Filed  herewith.                                                                                                                                                                                                                                                                        |
| 10.18                     |       | Letter  of Credit Reimbursement Agreement, dated April 17, 2006, between MAIR  Holdings, Inc. and First Interstate Bank. Filed herewith.                                                                                                                                                                                                                                 |
| 10.19                     |       | Irrevocable  Standby Letter of Credit dated April 17, 2006, in the amount of $13,000,000.  Filed herewith.                                                                                                                                                                                                                                                               |
| 14.1                      |       | Code  of Ethics. Incorporated by reference to Exhibit 14 to the Company’s Form 10-K  for the fiscal year ended March 31, 2004.                                                                                                                                                                                                                                      |

 

 

98

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| 21.1   |   | Subsidiaries.  Incorporated by reference to Exhibit 21 to the Company’s Form 10-Q for the  quarter ended December 31, 2002. |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------|
| 23.1   |   | Consent  of Independent Registered Public Accounting Firm. Filed herewith.                                                       |
| 24.1   |   | Powers  of Attorney. Included in signature page.                                                                                 |
| 31.1   |   | Chief  Executive Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002. Filed herewith.               |
| 31.2   |   | Chief  Financial Officer Certification Pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002. Filed herewith.               |
| 32.1   |   | Certification  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Filed herewith.                                        |
|   |   |                                                                                                                             |

 

 

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