** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

**FORM 10-Q**

**x****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934.**

**For the quarterly period ended June 30, 2006**

**OR**

**o****TRANSITION REPORT PURSUANT TO SECTION13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

**For the transition period from           to**

**Commission File No:  0-17895**

**MAIR HOLDINGS, INC.**

Incorporated under the laws of Minnesota

**41-1616499**

(I.R.S. Employer ID No.)

**FifthStreet Towers, Suite 1360**

**150 SouthFifth Street**

**Minneapolis,MN  55402**

**(612) 333-0021**

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes x    Noo

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer.  Seedefinition of “accelerated filing and large accelerated filer in Rule 12b-2 ofthe Exchange Act.  (Check one):

Large AcceleratedFiler o                                  AcceleratedFiler x                                            Non-AcceleratedFiler o

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes o    Nox

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.

| **Class**                               |   | **Outstanding  as of June 30, 2006** |
|-----------------------------------------|--------|--------------------------------------|
| Common Stock,  par value $.01 per share |   | 20,591,840                           |

 

 

 

----

#  

# **CAUTIONARYNOTE REGARDING FORWARD-LOOKING STATEMENTS**

Statements in thisQuarterly Report on Form 10-Q of MAIR Holdings, Inc. (“MAIR” or the “Company”)under the caption “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” and elsewhere in this report are forward-looking andare based upon information currently available to the Company.  The Company, through its officers, directorsor employees, may also from time to time make oral forward-lookingstatements.  In connection with the “safeharbor” provisions of the Private Securities Litigation Reform Act of 1995, theCompany notes that a variety of material risks and uncertainties could causeactual results to differ materially from those contained in any forward-lookingstatement made by or on behalf of the Company. Many important factors that could cause such a difference are describedunder the caption “Risk Factors” in Item 1A of Part II of this Quarterly Reporton Form 10-Q.

Unduereliance should not be placed on the Company’s forward-looking statementsbecause the matters they describe are subject to known and unknown risks,uncertainties and other unpredictable factors, many of which are beyond theCompany’s control.  The Company’s forward-looking statements are based onthe information currently available and speak only as of the date on which thisreport was filed with the United States Securities and Exchange Commission (“SEC”). Over time, actual results, performance or achievements will likely differ fromthe anticipated results, performance or achievements that are expressed orimplied by the Company’s forward-looking statements, and such differences mightbe significant and materially adverse to the Company’s shareholders.

Allsubsequent written or oral forward-looking statements attributable to theCompany or persons acting on the Company’s behalf are expressly qualified bythe factors described above.  The Company assumes no obligation, anddisclaims any obligation, to update information contained in this QuarterlyReport on Form 10-Q, including forward-looking statements, as a result offacts, events or circumstances after the date of this report, except asrequired by law in the normal course of its public disclosure practices.

2

----

 

**PARTI.  FINANCIAL INFORMATION**

**ITEM1.  CONDENSED CONSOLIDATED FINANCIALSTATEMENTS**

**MAIR HOLDINGS, INC. ANDSUBSIDIARIES**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(inthousands, except share information)**

**(Unaudited)**
|                                                                                                                      | ** ** | **June 30** | ** ** | **March 31** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-------------------|------------|
| ** **                                                                                                           | ** ** | **2006**         | ** ** | **2006**          | ** ** |
| ASSETS                                                                                                               |       |             |       |              |       |
|  CURRENT ASSETS:                                                                                                |       |             |       |              |       |
| Cash and cash equivalents                                                                                            |       | $                | 25,294     |              | $          | 47,135 |   |
| Short-term investments                                                                                               |       | 50,161           |       | 44,117            |       |
| Accounts receivable, net of reserve of $33                                                                           |       | 3,057            |       | 3,043             |       |
| Income taxes receivable                                                                                              |       | 919              |       | 941               |       |
| Inventories, net                                                                                                     |       | 884              |       | 589               |       |
| Prepaid expenses and deposits                                                                                        |       | 1,981            |       | 2,611             |       |
| Total current assets                                                                                                 |       | 82,296           |       | 98,436            |       |
|                                                                                                                 |       |             |       |              |       |
| PROPERTY AND  EQUIPMENT:                                                                                             |       |             |       |              |       |
| Flight equipment                                                                                                     |       | 713              |       | 650               |       |
| Other property and equipment                                                                                         |       | 1,418            |       | 1,401             |       |
| Less: Accumulated depreciation and amortization                                                                      |       | (695             | )          | (628              | )          |
| Net property and equipment                                                                                           |       | 1,436            |       | 1,423             |       |
|                                                                                                                 |       |             |       |              |       |
| NONCURRENT  ASSETS:                                                                                                  |       |             |       |              |       |
| Long-term investments                                                                                                |       | 19,413           |       | 19,484            |       |
| Other intangible assets, net                                                                                         |       | 2,311            |       | 2,413             |       |
| Restricted cash                                                                                                      |       | 13,100           |       | —            |       |
| Other assets, net                                                                                                    |       | 199              |       | 186               |       |
|                                                                                                                 |       | $                | 118,755    |              | $          | 121,942 |   |
|                                                                                                                 |       |             |       |              |       |
| LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                            |       |             |       |              |       |
| CURRENT  LIABILITIES:                                                                                                |       |             |       |              |       |
| Accounts payable                                                                                                     |       | $                | 1,975      |              | $          | 2,745 |   |
| Intercompany payable to Mesaba Aviation, Inc.                                                                        |       | 251              |       | 54                |       |
| Accrued liabilities:                                                                                                 |       |             |       |              |       |
| Payroll                                                                                                              |       | 1,326            |       | 1,421             |       |
| Deferred income                                                                                                      |       | 680              |       | 716               |       |
| Other current liabilities                                                                                            |       | 7,693            |       | 7,635             |       |
| Total current liabilities                                                                                            |       | 11,925           |       | 12,571            |       |
|                                                                                                                 |       |             |       |              |       |
| OTHER NONCURRENT  LIABILITIES                                                                                        |       | 714              |       | 772               |       |
| Total liabilities                                                                                                    |       | 12,639           |       | 13,343            |       |
|                                                                                                                 |       |             |       |              |       |
| COMMITMENTS AND  CONTINGENCIES (Note 11)                                                                             |       |             |       |              |       |
|                                                                                                                 |       |             |       |              |       |
| 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 shares issued and outstanding                |       | 206              |       | 206               |       |
| Paid-in capital                                                                                                      |       | 69,661           |       | 69,546            |       |
| Accumulated other comprehensive loss                                                                                 |       | (280             | )          | (176              | )          |
| Retained earnings                                                                                                    |       | 36,529           |       | 39,023            |       |
| Total shareholders’ equity                                                                                      |       | 106,116          |       | 108,599           |       |
|                                                                                                                 |       | $                | 118,755    |              | $          | 121,942 |   |

 

The accompanyingnotes are an integral part of these unaudited condensed consolidated financialstatements.

3

----

 

**MAIRHOLDINGS, INC. AND SUBSIDIARIES**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(inthousands)**

**(Unaudited)**

 
|                                                                                                                 | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                      | ** ** | **June 30**                 | ** ** |
| ** **                                                                                                      | ** ** | ** **                       | ** ** | **As restated - see  Note 12** | ** ** |
| ** **                                                                                                      | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **                                                                                                      | ** ** | ** **                       | ** ** | ** ** | ** ** |
| OPERATING  REVENUES:                                                                                            |       |                             |       |   |   |
| Passenger                                                                                                       |       | $                                | 3,680      |   | $ | 103,783 |   |
| Freight and other                                                                                               |       | 2,363                            |       | 10,900 |   |
| Total operating revenues                                                                                        |       | 6,043                            |       | 114,683 |   |
| OPERATING  EXPENSES:                                                                                            |       |                             |       |   |   |
| Wages and benefits                                                                                              |       | 2,472                            |       | 39,388 |   |
| Aircraft fuel                                                                                                   |       | 1,451                            |       | 958 |   |
| Aircraft maintenance                                                                                            |       | 911                              |       | 22,771 |   |
| Aircraft rents                                                                                                  |       | 453                              |       | 25,665 |   |
| Landing fees                                                                                                    |       | 95                               |       | 2,620 |   |
| Insurance and taxes                                                                                             |       | 675                              |       | 1,893 |   |
| Depreciation and amortization                                                                                   |       | 178                              |       | 3,802 |   |
| Administrative and other                                                                                        |       | 3,602                            |       | 18,504 |   |
| Total operating expenses                                                                                        |       | 9,837                            |       | 115,601 |   |
| Operating loss                                                                                                  |       | (3,794                           | )          | (918 | ) |
| NONOPERATING  INCOME (EXPENSE):                                                                                 |       |                             |       |   |   |
| Interest income and other                                                                                       |       | 1,317                            |       | 1,012 |   |
| Interest expense                                                                                                |       | (17                              | )          | (16 | ) |
| Arbitration settlement                                                                                          |       | —                           |       | 1,800 |   |
| Other nonoperating income, net                                                                                  |       | 1,300                            |       | 2,796 |   |
| (Loss) income before benefit (provision) for income  taxes and equity in income (loss) of Mesaba Aviation, Inc. |       | (2,494                           | )          | 1,878 |   |
|                                                                                                            |       |                             |       |   |   |
|  BENEFIT (PROVISION) FOR INCOME TAXES                                                                      |       | —                           |       | (676 | ) |
| (Loss) income before equity in income (loss) of Mesaba  Aviation, Inc.                                          |       | (2,494                           | )          | 1,202 |   |
|                                                                                                            |       |                             |       |   |   |
| EQUITY IN INCOME  (LOSS) OF MESABA AVIATION, INC.                                                               |       | —                           |       | — |   |
|                                                                                                            |       |                             |       |   |   |
| NET (LOSS)  INCOME                                                                                              |       | $                                | (2,494     | ) | $ | 1,202 |   |
|                                                                                                            |       |                             |       |   |   |
| NET (LOSS)  INCOME PER SHARE:                                                                                   |       |                             |       |   |   |
| (Loss) earnings per common share - basic                                                                        |       | $                                | (0.12      | ) | $ | 0.06 |   |
| (Loss) earnings per common share - diluted                                                                      |       | $                                | (0.12      | ) | $ | 0.06 |   |
|                                                                                                            |       |                             |       |   |   |
| WEIGHTED AVERAGE  SHARES OUTSTANDING:                                                                           |       |                             |       |   |   |
| Basic                                                                                                           |       | 20,592                           |       | 20,574 |   |
| Diluted                                                                                                         |       | 20,592                           |       | 21,194 |   |

 

The accompanyingnotes are an integral part of these unaudited condensed consolidated financialstatements.

4

----

 

**MAIRHOLDINGS, INC. AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(in thousands)**

**(Unaudited)**

 
|                                                                                                     | ** ** | Three Months Ended | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                          | ** ** | **June 30**             | ** ** |
| ** **                                                                                          | ** ** | **2006**                     | ** ** | **2005** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                              |       |                         |       |   |   |
| Net (loss) income                                                                                   |       | $                            | (2,494     | ) | $ | 1,202 |   |
| Adjustments to reconcile net (loss) income to net  cash (used in) provided by operating activities: |       |                         |       |   |   |
| Depreciation and amortization                                                                       |       | 178                          |       | 3,802 |   |
| Amortization of deferred credits                                                                    |       | (27                          | )          | (348 | ) |
| Stock-based compensation                                                                            |       | 115                          |       | 22 |   |
| Amortization of investment (premiums) discounts                                                     |       | (336                         | )          | 465 |   |
| Changes in current operating items:                                                                 |       |                         |       |   |   |
| Accounts receivable                                                                                 |       | (14                          | )          | 3,498 |   |
| Income taxes receivable                                                                             |       | 22                           |       | — |   |
| Inventories                                                                                         |       | (295                         | )          | (921 | ) |
| Prepaid expenses and deposits                                                                       |       | 630                          |       | 240 |   |
| Accounts payable and other                                                                          |       | (854                         | )          | (2,979 | ) |
| Net cash (used in) provided by operating activities                                                 |       | (3,075                       | )          | 4,981 |   |
|                                                                                                |       |                         |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                              |       |                         |       |   |   |
| Purchases of investments                                                                            |       | (10,559                      | )          | (11,441 | ) |
| Sales of investments                                                                                |       | 4,807                        |       | 18,002 |   |
| Purchases of property and equipment                                                                 |       | (80                          | )          | (2,964 | ) |
| Increase in restricted cash                                                                         |       | (13,100                      | )          | — |   |
| Net cash (used in) provided by investing activities                                                 |       | (18,932                      | )          | 3,597 |   |
|                                                                                                |       |                         |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES                                                               |       |                         |       |   |   |
| Payment of other noncurrent liabilities                                                             |       | (31                          | )          | (30 | ) |
| Increase in intercompany payable to Mesaba Aviation,  Inc.                                          |       | 197                          |       | — |   |
| Net cash provided by (used in) financing activities                                                 |       | 166                          |       | (30 | ) |
|                                                                                                |       |                         |       |   |   |
| NET (DECREASE)  INCREASE IN CASH AND CASH EQUIVALENTS                                               |       | (21,841                      | )          | 8,548 |   |
| CASH AND CASH  EQUIVALENTS:                                                                         |       |                         |       |   |   |
| Beginning of year                                                                                   |       | 47,135                       |       | 57,968 |   |
| End of year                                                                                         |       | $                            | 25,294     |   | $ | 66,516 |   |
|                                                                                                |       |                         |       |   |   |
| SUPPLEMENTARY  CASH FLOW INFORMATION:                                                               |       |                         |       |   |   |
| Cash paid (refund received) during period for:                                                      |       |                         |       |   |   |
| Interest                                                                                            |       | $                            | 18         |   | $ | 17 |   |
| Income taxes                                                                                        |       | $                            | —     |   | $ | (420 | ) |

 

The accompanying notesare an integral part of these unaudited condensed consolidated financialstatements.

5

----

 

**MAIR HOLDINGS, INC. ANDSUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

The condensedconsolidated financial statements included herein have been prepared by theCompany without audit, pursuant to the rules and regulations of the Securitiesand Exchange Commission (“SEC”).  Theinformation furnished in the condensed consolidated financial statementsincludes normal recurring adjustments, unless otherwise noted, and reflects alladjustments that are, in the opinion of management, necessary for the fairpresentation of such condensed consolidated financial statements.  The Company’s business is seasonal and,accordingly, interim results are not indicative of results for a fullyear.  Certain information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of America (“GAAP”)have been condensed or omitted pursuant to such rules and regulations, althoughthe Company believes that the disclosures are adequate to make the informationpresented not misleading.  Thesecondensed consolidated financial statements should be read in conjunction withthe consolidated financial statements for the year ended March 31, 2006, andthe notes thereto, included in the Company’s Annual Report on Form 10-K filedwith the SEC on June 27, 2006.

**1.****              Basis ofPresentation, Corporate Organization and Business**

*CorporateOrganization*

The condensedconsolidated financial statements include the accounts of MAIR Holdings, Inc. (“MAIR”or the “Company”) and its wholly-owned subsidiaries, Big Sky Transportation Co.(“Big Sky”) and Mesaba Aviation, Inc. (“Mesaba”) until Mesaba’s bankruptcyfiling on October 13, 2005.  Allintercompany transactions and balances have been eliminated in consolidation.  As discussed below, the accounts of Mesabahave been deconsolidated from the Company’s condensed consolidated financialstatements effective October 13, 2005. Since October 13, 2005 intercompany balances between MAIR and Mesabahave not been eliminated.

As discussed in Note 2,Mesaba filed a voluntary petition for relief under Chapter 11 of the UnitedStates Bankruptcy Code (“Bankruptcy Code”) in the United States BankruptcyCourt for the District of Minnesota (the “Bankruptcy Court”) on October 13,2005. Mesaba is operating its business as a debtor-in-possession pursuant tothe Bankruptcy Code.  Mesaba’s financialstatements have been prepared on a going concern basis, which contemplatescontinuity of operations, realization of assets and liquidation of postpetitionliabilities in the ordinary course of business.

Due to Mesaba’sbankruptcy and the uncertainties surrounding the nature, timing, and specificsof the bankruptcy proceedings, MAIR deconsolidated Mesaba’s financial resultsunder the equity method of accounting effective October 13, 2005.  As a result, Mesaba’s assets and liabilitieshave been removed from the Company’s condensed consolidated balance sheet as ofMarch 31, 2006 (see Note 2).  Mesaba’sresults of operations have been removed from the Company’s condensedconsolidated results of operations and cash flows since October 13, 2005, butcontinue to be included in such condensed consolidated financial statements forperiods prior to October 13, 2005.

MAIR has accounted forMesaba’s financial results under the equity method of accounting since Mesaba’sbankruptcy filing on October 13, 2005. In accordance with APB Opinion No. 18, *The EquityMethod of Accounting for Investments in Common Stock*, at March 31,2006, MAIR evaluated whether its investment in Mesaba had experienced another-than-temporary impairment.  MAIR’sevaluation utilized a market and income approach, including a discounted cashflow analysis.  After analyzing Mesaba’sactual losses in fiscal 2006, Mesaba’s projected losses in fiscal 2007 as ittransitions to a Saab-only operation, Mesaba’s five-year Saab business plan andMesaba’s liabilities subject to compromise as of March 31, 2006, MAIR concludedthat its remaining investment in Mesaba had experienced an other-than-temporaryimpairment.  Accordingly, effective March31, 2006, MAIR recorded an $8.9 million impairment charge to write off itsremaining equity investment in Mesaba.

6

----

 

During the firstquarter of fiscal 2007 Mesaba reported net income of $0.1 million, consistingof an operating loss of $1.6 million, a cumulative effect of a change inaccounting principle of $0.5 million, offset by nonoperating income of $2.2million.  MAIR continues to believe thatits investment in Mesaba remains other-than-temporarily impaired at June 30,2006 as Mesaba is projecting significant losses over the remainder of fiscal2007.  Accordingly, MAIR did not recordany equity in the income of Mesaba during the quarter ended June 30, 2006.

The provisions ofStatement 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 GAAP in the preparation of financialstatements.  However, SOP 90-7 doesrequire that the financial statements, for periods including and subsequent tothe filing of the Chapter 11 petition, distinguish transactions and events thatare directly associated with the reorganization from the ongoing operations ofthe business.  See Note 13 for thecondensed financial statements of Mesaba presented in accordance with SOP 90-7on a stand-alone basis as of June 30, 2006 and March 31, 2006 and for the threemonths ended June 30, 2006 and 2005.

*Business*

Mesaba

Mesaba operates as aregional carrier providing scheduled passenger service as MesabaAirlines/Northwest Airlink and Mesaba Airlines/Northwest Jet Airlink under aten-year omnibus Airline Service Agreement (“ASA”) with Northwest Airlines,Inc. (“Northwest”) dated August 29, 2005. Neither Mesaba nor Northwest has assumed or rejected the ASA in theirrespective bankruptcy proceedings, and Mesaba is continuing to operate underthe terms of the ASA (see Note 2 regarding Northwest filing for Chapter 11bankruptcy protection on September 14, 2005 and the effect of such filing onthe ASA).  Prior to the ASA, Mesabaprovided regional airline services to Northwest pursuant to two separate agreements,an Airline Service Agreement (the “Airlink Agreement”) that governed Mesaba’soperation of Saab 340 jet-prop aircraft (“Saab”), and a Regional Jet ServicesAgreement (the “Jet Agreement”) that governed Mesaba’s operation of Avro RJ85regional jets (“Avro”).  The ASA is anomnibus agreement that incorporates the existing payment terms for the Saabsand the Avros contained in the Airlink Agreement and the Jet Agreement and addsnew payment terms for the Canadair regional jets (“CRJs”) that Mesaba beganoperating in October 2005.  As of June 30,2006, Mesaba served 98 cities in the United States and Canada from Northwest’shub airports located in Minneapolis/St. Paul, Detroit and Memphis.

Northwest purchasesMesaba’s entire capacity and pays Mesaba in arrears on the 11th and 26th ofeach month for regional airline services that Mesaba provides to Northwestutilizing the Saabs and Avros.  Beginningin October 2005, Northwest began paying Mesaba, on a regular bi-monthly basis,on the 1st and 16th of each month for regional airline services that Mesabaprovides to Northwest utilizing the CRJs. The CRJ payment made on the 1st ofeach month represents a prepayment based on an estimate of regional airlineservices to be provided by Mesaba for the first 15 days of the month.  The CRJ payment made on the 16th of the monthconsists of a prepayment based on an estimate of regional airline services tobe provided by Mesaba for the 16th through the end of the month and a true-upamount adjusting for actual services provided by Mesaba in the prior month.

For flights utilizing theSaabs, Mesaba recognizes revenue for each completed available seat mile, or ASM(the number of seats in an aircraft multiplied by the number of miles thoseseats are flown), and purchases fuel (which is set at a fixed price of 83.5 centsper gallon), ground handling and other services from Northwest.

For flights utilizing theAvros, Mesaba recognizes revenue for each block hour flown (the elapsed timebetween aircraft departing and arriving at a gate).  Northwest provides fuel and airport andpassenger related services at Northwest’s expense for the Avros.

For flights utilizing theCRJs, Mesaba recognizes revenue through monthly expense reimbursement paymentsfor actual expenses incurred relating to aircraft rent, maintenance, landing feesand fuel (which is set at a fixed price of 70 cents per gallon); 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 describedabove calculated to achieve a target operating margin.  The target operating margin through April2007 is set at a fixed amount, after which time the target operating margin

7

----

 

will be based on theaverage operating margin of the publicly traded United States domestic regionalairlines operating primarily regional jet aircraft, excluding Pinnacle AirlinesCorp. (“Pinnacle”) and any regional carrier under bankruptcy protection,subject to a margin cap and floor.

The ASA containstermination provisions that allow both Mesaba and Northwest to terminate theASA in the event the other party breaches the agreement, subject to the otherparty’s right to cure the breach within a prescribed time period.  Additionally, Northwest may terminate the ASAin the event of certain lease and other performance defaults by Mesaba; failureby Mesaba to maintain required insurance coverage; failure by Mesaba to allowinspections pursuant to the ASA; change in control events; revocation orfailure by Mesaba to obtain Department of Transportation (“DOT”) certification;if Mesaba or its affiliates operate an aircraft type that causes Northwest tobe in violation of its collective bargaining agreement with its pilots; failureto elect a chief executive officer/president of MAIR or Mesaba reasonablyacceptable to Northwest; if a specified percentage of the aircraft subject tothe agreement are not operated for a specified period of time, other than as aresult of the Federal Aviation Administration (“FAA”) grounding all aircraftfor all carriers; if there is a strike; cessation or interruption of workinvolving Mesaba’s pilots, flight attendants or mechanics providing service; orif MAIR breaches its agreement entered into with Northwest concurrently withthe ASA.

Under the ASA, allscheduled flights that Mesaba operates are designated as Northwest flightsusing Northwest’s designator code in all computer reservation systems, with anasterisk and a footnote indicating that Mesaba is the carrier providing theservice.  In addition, flight schedulesof Mesaba and Northwest are closely coordinated to facilitate interlineconnections, and Mesaba’s passenger gate facilities at the Minneapolis/St. PaulInternational Airport, Detroit Metropolitan Airport and Memphis InternationalAirport are integrated with Northwest’s facilities in the main terminalbuildings.

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

The ASA provides forincentive payments from Northwest to Mesaba based on achievement of certainoperational goals on a semi-annual basis. Such incentives totaled $1.2 million and $1.4 million for the threemonths ended June 30, 2006 and 2005, respectively, and are included inpassenger revenues in Mesaba’s condensed statements of operations (see Note13).

Approximately $24.0million, or 89.2%, and $25.7 million, or 88.1%, of the respective June 30, 2006and March 31, 2006 net accounts receivable balances in Mesaba’s condensedbalance sheets were due from Northwest and were not collateralized (see Note13).  Approximately 94.8% and 95.2% ofMesaba’s operating revenue recognized for the three months ended June 30, 2006and 2005, respectively, was from Northwest. Accounts payable owed to Northwest by Mesaba, primarily for groundhandling, was $0.2 million and $0.1 million as of June 30, 2006 and March 31,2006, respectively.  Mesaba paidNorthwest $5.3 million and $3.3 million for ground handling and other servicesfor the three months ended June 30, 2006 and 2005 respectively.

Upon execution of theASA, and pursuant to a separate agreement between MAIR and Northwest, MAIRissued to Northwest an amended and restated warrant (the “Warrant”) to replacethe warrants held by Northwest to reduce the number of shares of MAIR’s commonstock issuable upon exercise from 4,151,922 shares exercisable at pricesranging from $7.25 to $21.25 per share to an aggregate of 4,112,500 sharesexercisable at a price of $8.74 per share. The Warrant expires ten years from the date of the ASA.  The Warrant will become exercisable for sixtypercent of the shares upon the delivery by Northwest of the 15th CRJ aircraft to Mesaba and an additional 4% ofthe shares with each subsequent delivery of each of the next ten CRJ aircraft.

As of June 30, 2006,Northwest had delivered only two CRJ aircraft to Mesaba.  Northwest removed one of the CRJs from Mesaba’sschedule at the end of June 2006 and placed it 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, one by Compass, and one by Mesaba.  Mesaba has submitted a proposal to conductall CRJ flying for Northwest.  If

8

----

 

Mesaba is not awardedsome or all of the CRJ business, Northwest will remove the remaining CRJ thatMesaba currently operates.

In connection with theASA, and pursuant to its separate agreement with Northwest, MAIR made a capitalcontribution of approximately $31.7 million to Mesaba in September 2005, justprior to Northwest filing for bankruptcy (see Note 2). MAIR also entered into aregistration rights agreement to cover the registration of the shares of stockcurrently held by Northwest and the shares of stock to be issued to Northwestupon exercise of the Warrant.

There are othersignificant related party transactions and balances between Northwest andMesaba disclosed throughout the Notes to the Condensed Consolidated FinancialStatements.  Loss of Mesaba’s businessrelationship with Northwest or Northwest’s failure to make timely payment of amountsowed to Mesaba would have a material adverse effect on Mesaba’s operations,financial position and cash flows.

Big Sky

Big Sky operates as aregional air carrier based in Billings, Montana, providing scheduled passenger,freight, express package and charter services. As of June 30, 2006, Big Sky provided scheduled air service to 22communities 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 theEssential Air Service (“EAS”) program with the DOT.  The EAS program subsidizes air carriers toprovide air service to designated rural communities throughout the UnitedStates that could not otherwise economically justify that service based ontheir passenger traffic.  The DOT paysEAS subsidies for each departure in a covered market.  During the three months ended June 30, 2006and 2005, Big Sky recognized revenue from EAS subsidies of $2.2 million and$2.0 million, respectively.

*RecentDevelopments*

On July 12, 2006, Big Skyentered into an agreement with Flying Boat, Inc., d/b/a Chalk’s InternationalAirlines, to operate two Beechcraft 1900D aircraft for Flying Boat, Inc. forone year.  Under the agreement, Big Skywill initially operate the aircraft between Florida and the Bahamas.  The agreement provides compensation to BigSky for a minimum monthly level of flying and contains two one-year optionalextensions.  Under the terms of theagreement, Big Sky will not assume any risk associated with revenue or fuelexpense.

*Use ofEstimates*

The preparation offinancial statements in conformity with GAAP requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities, as well as thereported amounts of revenues and expenses. The most significant uses of estimates relate to the allowance fordoubtful accounts, accrued maintenance expenses, aircraft property andequipment lives, inventory obsolescence reserves, valuation of intangibleassets, and accounting for income taxes. Ultimate results could differ from those estimates.

*Reclassification*

Certain amounts withinaccounts receivable previously reported in the accompanying condensedconsolidated balance sheet as of March 31, 2006 have been reclassified toconform to the fiscal 2007 presentation. The reclassification had no effect on previously reported total currentassets.

**2.****              Northwest and MesabaBankruptcy Filings**

*NorthwestBankruptcy Filing*

On September 12, 2005,Northwest failed to make a payment of approximately $18.7 million due to Mesabafor services provided 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 bankruptcyprotection under Chapter 11 of the Bankruptcy Code.  On September 26, 2005, Northwest made apayment of approximately $1.6 million to Mesaba, which payment was to be forservices provided by Mesaba to Northwest from September 1 to September 15, 2005.

9

----

 

Because Northwest’sbankruptcy petition was filed on September 14, Northwest paid only that portionof the payment attributable 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 againstMesaba.  On October 26, 2005, Northwestpaid Mesaba approximately $10.5 million for services provided by Mesaba fromOctober 1 to October 15, 2005.  Northwestdeducted approximately $6.1 million from the total amount due, the majority ofwhich related to aircraft payments Mesaba did not make to Northwest followingMesaba’s own bankruptcy filing on October 13, 2005 (see below).

At the time of Northwest’sbankruptcy filing on September 14, 2005, Mesaba estimated that Northwest owedMesaba approximately $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 concluded thatit was necessary to establish a reserve of $31.9 million for amounts thatMesaba may not ultimately collect from Northwest.  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.  Although Mesaba maintained the above reserveas of June 30, 2006, Mesaba will continue to actively seek reimbursementthrough the bankruptcy process and any other means, including any futurediscussions Mesaba may have with Northwest regarding the ASA.

Generally, all amountsthat Northwest owed to its creditors at the time of its filing were stayed bythe bankruptcy filing.  Mesaba’s claimsrelating to such prepetition amounts are unsecured claims.  Northwest’s bankruptcy court has establishedAugust 16, 2006 as the last date and time for the filing of proofs of claimagainst Northwest.  All claims that aroseon or prior to September 14, 2005, the date of Northwest’s bankruptcy filing,must be filed on a proof of claim by the bar date.

At any time duringNorthwest’s bankruptcy proceedings, Northwest has the option to assume orreject the ASA and related agreements, pending approval of the bankruptcy courtand a committee representing Northwest’s unsecured creditors.  If Northwest assumes the ASA, prepetitionamounts owed to Mesaba would become an administrative claim and Mesaba couldreceive payment in full.  If Northwestrejects the ASA and related contracts, then prepetition amounts owed to Mesabawould 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 Northwest’s plan of reorganization is approved by its bankruptcycourt.  Mesaba believes that, even ifNorthwest intends to continue its relationship with Mesaba, Northwest willattempt to renegotiate the ASA with Mesaba before Northwest will seek to assumethe ASA.  This renegotiation couldinclude a negotiation of the amount that Northwest will ultimately pay Mesabain settlement of the net prepetition amounts that Northwest owes toMesaba.  However, the exact nature ofMesaba’s future relationship with Northwest may not be known until such time asNorthwest and Mesaba adopt their respective bankruptcy reorganization plans.

Since its bankruptcyfiling, Northwest has also proposed and implemented various changes to Mesaba’sfleet.  Northwest idled nine of the Avrosoperated by Mesaba from Northwest’s schedule effective October 31, 2005.  Northwest idled an additional three Avros andremoved 11 Saabs from the schedule effective January 4, 2006.  As of July 31, 2006, Northwest removed oneCRJ, two additional Saabs and ten additional Avros.  Northwest intends to terminate all theremaining aircraft, other than 49 Saabs, by the end of calendar 2006, subjectto final lease negotiations between Northwest and its lessors.  As of July 31, 2006, Mesaba was operating 13Avros, 50 Saabs and one CRJ pursuant to the ASA.

*MesabaBankruptcy Filing*

Northwest’s missedpayments to Mesaba and Northwest’s actions regarding its fleet and schedulechanges adversely affected Mesaba. Specifically, Mesaba determined that due to Northwest’s failure to makethe September 12, 2005 payment, the deductions taken by Northwest againstsubsequent payments and the reduced revenues Mesaba would receive because ofthe fleet and schedule changes dictated by Northwest, Mesaba could not sustainits operations outside of court protection under Chapter 11 of the BankruptcyCode.  As a result, on October 13, 2005(the “Petition Date”), Mesaba filed for bankruptcy protection under Chapter 11of the Bankruptcy Code.  Mesaba continuesto operate 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 to

10

----

 

operate as an ongoingbusiness, but may not engage in transactions outside the ordinary course ofbusiness without the prior approval of the Bankruptcy Court.

All of Mesaba’s vendorsare being paid for all goods furnished and services provided to Mesaba afterthe 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, except for liabilities relating to certain qualifyingaircraft, aircraft engines and other aircraft-related equipment that are leasedor subject 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, theBankruptcy Court approved Mesaba’s rejection of the leases for 11 Saab B modelaircraft leased from Pinnacle.  On June 8, 2006, after Northwest rejectedthe head leases related to twelve Avro aircraft (nine of which had been removedfrom Mesaba’s schedule on October 30, 2005, and three of which had been removedfrom the schedule on January 4, 2006), Mesaba received approval from itsBankruptcy Court to reject the subleases on those same aircraft.  On April7, 2006, Mesaba received Bankruptcy Court approval to reject the leases relatedto two additional Saabaircraft.  Effective July 1, 2006, Northwest also rejected the subleasewith Mesaba related to one of Mesaba’s CRJ aircraft and transferred thataircraft to Compass.  In addition,Northwest has negotiated agreements with its head lessors to provide for theorderly return to the head lessors of an additional 23 Avro aircraft, thebalance of Mesaba’s Avro fleet, between April and December 2006.  With theBankruptcy Court’s approval, Mesaba has executed similar agreements withNorthwest to allow for those same Avro aircraft to be returned toNorthwest.  Mesaba anticipates that the remaining Saab A model aircraftand the remaining CRJ aircraft will be removed from its fleet by  the endof the calendar year, leaving Mesaba with a fleet of 49 aircraft (the 49 SaabB+ models currently subleased from Northwest).

Under Section 365 of theBankruptcy Code, Mesaba may assume, assume and assign, or reject certainexecutory contracts and unexpired leases, including leases of real property,subject to the approval of the Bankruptcy Court and certain otherconditions.  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. In general, if Mesaba rejects an executory contract or unexpired lease,it is treated as a prepetition breach of the lease or contract in question and,subject to certain exceptions, relieves Mesaba of performing any futureobligations.  However, such a rejectionentitles the lessor or contract counterparty to a prepetition general unsecuredclaim for damages caused by such deemed breach and, accordingly, thecounterparty may file a claim against Mesaba for such damages.  As a result, liabilities subject tocompromise of $59.1 million reported in Mesaba’s condensed balance sheet as ofJune 30, 2006 (see Note 13) are likely to change in the future as a result ofdamage claims created by Mesaba’s rejection of various aircraft leases,executory contracts and unexpired leases. Generally, if Mesaba assumes an aircraft financing agreement, executorycontract or unexpired lease, Mesaba is required to cure existing defaults undersuch contract or lease as a condition to such assumption.

The bar date fornon-governmental entities to file proofs of claim against Mesaba was February28, 2006 (the “Bar Date”).  Proofs ofclaim aggregating $216.8 million were filed by that date.  Mesaba’s management and bankruptcy counselhave reviewed and assessed these proofs of claim to eliminate duplicativeclaims and claims without merit, as well as to adjust the amounts of certainproofs of claim based on management’s estimate of the likelihood that the claimwill be allowed by the Bankruptcy Court. As of June 30, 2006, Mesaba estimated the value of the allowable claimsat $59.1 million.  See Note 13 forfurther discussion of Mesaba’s liabilities subject to compromise.

The Bankruptcy Codeprovides special treatment for collective bargaining agreements (“CBAs”). Inparticular, Section 1113(c) of the Bankruptcy Code permits Mesaba to move toreject its CBAs if Mesaba first satisfies a number of statutorily prescribedsubstantive and procedural prerequisites and obtains the Bankruptcy Court’sapproval of the rejection or the expiration of the statutorily prescribed timeperiod. After bargaining in good faith and sharing relevant information withits unions, a debtor must make proposals to modify its existing CBAs based

11

----

 

on the most complete andreliable information available at the time. The proposed modifications must benecessary to permit the reorganization of a debtor and must provide that allthe affected parties are treated fairly and equitably. Ultimately, rejection ofthe CBAs is appropriate if the unions refuse to agree to a debtor’s necessaryproposal “without good cause” and the Bankruptcy Court determines that thebalance of the equities favors rejection. In February 2006, Mesaba commencedSection 1113(c) proceedings with unions for its pilots, flight attendants andmechanics.  On July 14, 2006, theBankruptcy Court granted Mesaba’s motion to reject its CBAs, but required thatMesaba provide ten days’ notice before it imposes new contract terms on itsunions.  Mesaba remains committed toreaching consensual labor agreements with each of its unions and is currentlyin negotiations with all three unions.

Pursuant to Mesaba’srequest for debtor-in-possession financing, Mesaba received a commitment letterfrom Marathon Structured Finance Fund, L.P. (“Marathon”) to providedebtor-in-possession financing, and on July 27, 2006, the Bankruptcy Courtapproved the payment of certain fees in connection with this financing.  The final hearing on approval of the proposedfinancing will be held on August 15, 2006. Under the terms of the financing, Mesaba may not receive funds fromMarathon unless certain conditions are met, including that of a laborresolution between Mesaba and its unions, which resolution may result fromMesaba imposing new contract terms on its unions or from Mesaba and its unionsreaching consensual agreements.  IfMesaba is unable to satisfy the conditions to obtain debtor-in-possessionfinancing or otherwise generate sufficient cash by the end of the secondquarter of fiscal 2007, Mesaba could be forced into liquidation.  MAIR has no obligation to fund Mesaba’soperations but may consider investing in Mesaba once Mesaba develops a plan ofreorganization.

To successfully emergefrom Chapter 11, in addition to obtaining exit financing if needed, 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 and potentially including the outcome of Northwest’s Chapter11 case.  Mesaba intends to file a planof reorganization 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.

**3.****              Intangible Assets**

The Company purchased BigSky in December 2002.  The excess of theBig Sky purchase price over the fair market value of the net assets acquiredwas allocated to certain identifiable intangible assets, including Big Sky’spilot labor contract and 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.  Based on the results of aninterim test performed at September 30, 2005, the Company determined thatgoodwill was impaired and recorded an impairment charge of $2.5 million infiscal 2006.

Intangible assetsand related accumulated amortization were as follows, in thousands:
|                                      | ** ** | June 30, 2006 | ** ** | **March 31, 2006** | ** ** |
|--------------------------------------|------------|-------------------------|------------|------------------------------|------------|
| ** **                           | ** ** | ** **              | ** ** | **Accumulated**              | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Gross**               | ** ** | **Amortization**             | ** ** | **Net** | ** ** | **Gross** | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Indefinite-lived  intangible assets: |       |                    |       |                         |       |   |   |   |   |   |   |   |   |
| Air carrier certificate              |       | $                       | 925        |                         |       |   | $ | 925 |   | $ | 925 |   |   |   | $ | 925 |   |
| Amortizable intangible  asset:       |       |                    |       |                         |       |   |   |   |   |   |   |   |   |
| Pilot labor contract                 |       | 2,840                   |       | (1,454                       | )          | 1,386 |   | 2,840 |   | (1,352 | ) | 1,488 |   |
|                                 |       | $                       | 3,765      |                         | $          | (1,454 | ) | $ | 2,311 |   | $ | 3,765 |   | $ | (1,352 | ) | $ | 2,413 |   |
|                                      |            |                         |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The amortizableintangible asset is being amortized over its estimated period of benefit.  Based on the current amount of intangibleassets subject to amortization, estimated amortization expense for each of thesucceeding four fiscal years will be $0.4 million per year.  During the fourth quarter of fiscal 2006, theCompany completed its annual impairment test of intangible assets anddetermined that no additional impairment charge was necessary.

12

----

**4.****              Investments**

Investments consistprincipally of government, agency, corporate and taxable municipal securitiesand are classified as available-for-sale. Fair value of investments 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 investments with an original maturity greater than one year aslong-term.

As of June 30, 2006 andMarch 31, 2006, cash, cash equivalents, short-term and long-term investmentstotaled $94.9 million (excluding $13.1 million in restricted cash for theletter of credit supporting MAIR’s guaranty of Mesaba’s obligations for thehangar at the Cincinnati/Northern Kentucky International Airport) and $110.7million, respectively.

Amortized cost,gross unrealized gains and losses and fair value of short- and long-terminvestments classified as securities available for sale were as follows, inthousands:

|                         | ** ** | **June 30, 2006** | ** ** | **March 31, 2006** | ** ** |
|-------------------------|------------|-----------------------------|------------|------------------------------|------------|
| Amortized cost          |       | $                           | 69,850     |                         | $          | 63,761 |   |
| Gross unrealized gains  |       | 4                           |       | 4                            |       |
| Gross unrealized losses |       | (280                        | )          | (164                         | )          |
| Fair value              |       | $                           | 69,574     |                         | $          | 63,601 |   |

 

For the three monthsended June 30, 2006 and 2005, the Company’s gross realized gains and losseswere insignificant.

At June 30, 2006 andMarch 31, 2006, Mesaba’s amortized cost and fair value of short- and long-terminvestments classified as securities available for sale was $9.9 million and $10.0million, respectively, of which $4.7 million and $4.5 million,respectively, is pledged as collateral for letters of credit. For the threemonths ended June 30, 2006 and fiscal year ended March 31, 2006 grossunrealized gains and losses were insignificant.

**5.****              Nonoperating Income**

In the firstquarter of fiscal 2006, the Company recognized $1.8 million as nonoperatingincome as a result of a favorable arbitration settlement with a formerinvestment advisor.

**6.****              Income Taxes**

*Consolidated*SFAS No. 109, *Accounting for IncomeTaxes*, requires all available evidence, both positive and negative,to be considered to determine whether, based on the weight of that evidence, avaluation allowance is needed.  Futurerealization of the tax benefits of an existing deductible temporary differenceor carryforward ultimately depends on the existence of sufficient taxableincome of the appropriate character within the carryback or carryforwardperiods available under the tax law.

The Company has performedsuch an analysis, and a valuation allowance was provided at the end of fiscal2006.  The Company continues to record avaluation allowance against its deferred tax assets due to the uncertaintyregarding the ultimate realization of those assets.  Therefore, the Company’s net loss for the threemonths ended June 30, 2006 was not reduced by any tax benefit.  The Company will continue to evaluate therealizability of the deferred tax assets on a quarterly basis.

*Mesaba*With respect to Mesaba, the Company also performed ananalysis in accordance with SFAS No. 109, and a full valuation allowance wasprovided at the end of fiscal 2006.  TheCompany continues to record a valuation allowance against its deferred taxassets due to the uncertainty regarding the ultimate realization of thoseassets.  Mesaba did not record any taxexpense on its income for the three months ended June 30, 2006 because ofits available tax loss carryforwards. Mesaba will continue to evaluate the realizability of the deferred taxassets on a quarterly basis.

13

----

In the event thatMesaba were to experience a change in ownership, as defined by Internal RevenueCode Section 382, upon emergence from bankruptcy the annual usage of theremaining tax attributes, primarily net operating losses that were generatedprior to the change in ownership, could be substantially limited. The amount oflimitation, if any, will be determined at the time of Mesaba’s emergence frombankruptcy.

**7.****              Stock-BasedCompensation**

Effective April 1, 2006,the Company adopted the fair value recognition provisions of SFAS No. 123R, *Share-Based Payment,*(“SFAS 123R”),**using the modified prospective transition method.Under that transition method, compensation expense that the Company recognizedbeginning on that date includes expense associated with the fair value of allawards granted on and after April 1, 2006, and expense for the unvested portionof previously granted awards outstanding on April 1, 2006. Results for priorperiods have not been restated.

Under SFAS 123R,forfeitures are estimated at the time of valuation and reduce expense ratablyover the vesting period.  This estimateis adjusted periodically based on the extent to which actual forfeitures differ,or are expected to differ, from the previous estimate.  Under SFAS 123 and APB 25, the Companyelected to account for forfeitures when awards were actually forfeited, atwhich time all previous pro forma expense was reversed to reduce pro formaexpense for that period.

*Stock Option Plans*The Company has approved stock option plans for keyemployees, directors, consultants and advisors to the Company.  Optionshave been granted and are presently outstanding under the Company’s 1994 StockOption Plan, 1996 Director Stock Option Plan and 2000 Stock IncentivePlan.  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 committee of the board of directors grantsthe options with vesting and exercise period being determined at the time ofthe award.  The purchase price of the stock for non-qualified and incentivestock options is determined at the time of the award and is generally equal tothe fair market value at the time of the award.

The fair value of eachoption grant is estimated on the date of grant using the Black-Scholes optionpricing model with the following assumptions: risk-free interest rate, stock price volatility and expected life.  The Company establishes the risk-freeinterest rate using the U.S. Treasury yield curve as of the grant date.  The expected volatility assumption is setbased primarily on historical volatility. The expected life assumption is set based on past exercise behavior ofoption holders.  For options granted, theCompany amortizes the fair value on a straight-line basis over the vestingperiod of the options.  There were nooptions granted during the three months ended June 30, 2006 or 2005.Accordingly, the Black-Scholes assumptions for those periods have not beenpresented.

For the three monthsended June 30, 2006, the adoption of SFAS 123R’s fair value method has resultedin additional expense in the amount of $0.1 million related to stockoptions.  This amount has been includedin the “Wages and benefits” caption in the accompanying condensed consolidatedstatement of operations for the three months ended June 30, 2006.  SFAS 123R also requires the benefits of taxdeductions in excess of recognized compensation cost to be reported as afinancing cash flow, rather than as an operating cash flow as required prior toSFAS 123R.  As the Company currently hasno excess tax benefits related to SFAS 123R, its adoption has not affected theCompany’s condensed consolidated statement of cash flows. The impact ofadopting SFAS 123R on future results will depend on, among other things, levelsof stock options granted in the future, actual forfeiture rates and the timingof option exercises.

14

----

A summary of stock optionactivity since the Company’s most recent fiscal year end is as follows:
| ** **                            | ** ** | **Stock Options** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate Intrinsic  Value** | ** ** |
|---------------------------------------|------------|------------------------|------------|------------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------|------------|
| ** **                            | ** ** | ** **             | ** ** | ** **                                     | ** ** | ** **                                          | ** ** | **(In thousands)**             | ** ** |
| Outstanding at March  31, 2006        |       | 1,559,176              |       | $                                              | 6.87       |                                                |       |                                |       |   |
| Granted                               |       | —                 |       | —                                         |       |                                                |       |                                |       |
| Exercised                             |       | —                 |       | —                                         |       |                                                |       |                                |       |
| Forfeited                             |       | 22,500                 |       | 7.66                                           |       |                                                |       |                                |       |
| Outstanding at June 30,  2006         |       | 1,536,676              |       | 6.85                                           |       | 4.72                                                |       | $                                   | 169        |   |
| Options exercisable at  June 30, 2006 |       | 1,324,176              |       | 6.72                                           |       | 4.24                                                |       | $                                   | 157        |   |
|                                       |            |                        |            |                                                |            |                                                     |            |                                     |            |  |  |

 

Theaggregate intrinsic value of options outstanding at June 30, 2006 is calculatedas the difference between the exercise price of the underlying option and themarket price of the common stock for the 704,782 options that had exerciseprices that were lower than the $6.21 market price of the Company’s commonstock at June 30, 2006.

*MesabaSARs*During fiscal 2004, Mesaba approved a stock appreciationrights (“SAR”) plan for key employees and directors. The exercise price of eachSAR is equal to the fair market value of the Company’s common stock on the dateof the award. Cash is paid based on the difference between the fair marketvalue at the date of grant and the date the SAR is exercised.  The SARs vest over four years and have aten-year term.

For the three monthsended June 30, 2006, the adoption of SFAS 123R’s fair value method has resultedin additional expense of $0.1 million related to the SARs.  This amount has been included in the “Wagesand benefits” caption in Mesaba’s condensed statement of operations for thethree months ended June 30, 2006.  Theimpact of adopting SFAS 123R on future results will depend on, among otherthings, levels of SARS granted in the future, actual forfeiture rates and thetiming of SAR exercises.

Upon adoption on April 1,2006, in accordance with SFAS 123R, Mesaba also recorded $0.5 million for thecumulative effect of change in accounting principle during the first quarter offiscal 2007 as a result of valuing SARs under the fair value method required bySFAS 123R.

A summary of Mesaba’s SARactivity since March 31, 2006 is as follows:
| ** **                         | ** ** | **Stock  Appreciation  Rights** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic Value** | ** ** |
|------------------------------------|------------|---------------------------------|------------|--------------------------------------------|------------|-----------------------------------------------------|------------|-------------------------------------|------------|
| ** **                         | ** ** | ** **                      | ** ** | ** **                                 | ** ** | ** **                                          | ** ** | **(In thousands)**             | ** ** |
| Outstanding at March  31, 2006     |       | 680,000                         |       | $                                          | 9.23       |                                                |       |                                |       |   |
| Granted                            |       | —                          |       | —                                     |       |                                                |       |                                |       |
| Exercised                          |       | —                          |       | —                                     |       |                                                |       |                                |       |
| Forfeited                          |       | 82,500                          |       | 9.39                                       |       |                                                |       |                                |       |
| Outstanding at June 30,  2006      |       | 597,500                         |       | 9.21                                       |       | 7.77                                                |       | $                                   | —     |   |
| SARs exercisable at  June 30, 2006 |       | 340,178                         |       | 9.27                                       |       | 7.74                                                |       | $                                   | —     |   |
|                                    |            |                                 |            |                                            |            |                                                     |            |                                     |            |  |  |

 

Theaggregate intrinsic value of SARs outstanding at June 30, 2006 was zero.  The aggregate intrinsic value is calculatedas the difference between the exercise price of the underlying SAR and themarket price of the common stock for the 579,500 SARs that had exercise pricesthat were lower than the $6.21 market price of the Company’s common stock atJune 30, 2006.

15

----

Mesaba used thefollowing assumptions to estimate the fair value of the SARs as of June 30,2006 and March 31, 2006:
| Risk-free interest rate |   | 5.1  | %      |
|-------------------------|--------|------|--------|
| Expected  volatility    |   | 46.4 | %      |
| Expected term  (years)  |   | 8    |   |
| Expected dividend yield |   | 0.0  | %      |

 

*Unrecognized Compensation*As of June 30, 2006, the Company had $0.5 million of totalunrecognized compensation cost related to non vested stock option compensationarrangements granted under all equity compensation plans.  Total unrecognized compensation will beadjusted for future changes in estimated forfeitures.  The Company expects to recognize the costover a weighted average period of two years.

As of June 30, 2006, Mesaba had $0.9 million of totalunrecognized compensation cost related to non vested SARs compensationarrangements granted under all equity compensation plans.  Total unrecognized compensation will beadjusted for future changes in estimated forfeitures.  Mesaba expects to recognize the cost over aweighted average period of two years.

*Pro Forma Results*Prior to April 1, 2006, the Company accounted for share-basedpayments using the intrinsic value method prescribed by APB 25 and SFAS 123.Under APB 25, if the exercise price of the Company’s employee stock optionsequaled the market price of the underlying stock on the date of the grant, nocompensation expense was recognized. Because the Company’s stock options weregranted with exercise prices at the market price of the underlying stock on thedate of grant, no compensation expense had been recognized under APB 25. Thefollowing table illustrates the effect on net income and earnings per shareassuming the compensation costs for the Company’s stock option plan had beenrecorded in the three months ended June 30, 2005 based on the fair value methodunder SFAS 123R, in thousands:
| Net income as reported                                                                                                                  |   | $      | 1,202  |   |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                            |   | 14     |   |
| Deduct:  Stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |   | (104   | )      |
|                                                                                                                                    |   | $      | 1,112  |   |
| Earnings per  share - basic                                                                                                             |   |   |   |
| As reported                                                                                                                             |   | $      | 0.06   |   |
| Pro forma                                                                                                                               |   | $      | 0.05   |   |
|                                                                                                                                    |   |   |   |
| Earnings per  share - diluted                                                                                                           |   |   |   |
| As reported                                                                                                                             |   | $      | 0.06   |   |
| Pro forma                                                                                                                               |   | $      | 0.05   |   |

 

**8.****              Earnings Per Share**

Basic earnings (loss) percommon share is computed by dividing net income (loss) by the weighted averagenumber of shares of common stock outstanding during the period.  Diluted earnings (loss) per share is computedby dividing net income (loss) by the sum of the weighted average number ofshares of common stock outstanding plus all additional common stock that wouldhave been outstanding if potentially dilutive common shares related to stockoptions and warrants had been issued. Stock options and warrants with an exercise price exceeding the fairmarket value of the Company’s common stock are considered antidilutive and areexcluded from the calculation. Incremental shares related to dilutive securities have an anti-dilutiveimpact on earnings per share when a net loss is reported and, therefore, arenot included in the calculation.

16

----

The following tablereconciles the number of shares utilized in the condensed consolidated earnings(loss) per share calculations for the periods ended June 30, in thousands:
|                                                                                           | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                | ** ** | **June 30**                 | ** ** |
| ** **                                                                                | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Net (loss)  income                                                                        |       | $                                | (2,494     | ) | $ | 1,202 |   |
| For earnings per  share - basic:                                                          |       |                             |       |   |   |
| Weighted average number of issued shares outstanding                                      |       | 20,592                           |       | 20,574 |   |
| Effect of  dilutive securities:                                                           |       |                             |       |   |   |
| Computed shares outstanding under stock option plans  utilizing the treasury stock method |       | —                           |       | 435 |   |
| Computed shares outstanding under warrants issued utilizing  the treasury stock method    |       | —                           |       | 185 |   |
| For earnings per  share - diluted:                                                        |       |                             |       |   |   |
| Weighted average common and potentially dilutive common  shares outstanding               |       | 20,592                           |       | 21,194 |   |
|                                                                                      |       |                             |       |   |   |
| Earnings (loss)  per share - basic                                                        |       | $                                | (0.12      | ) | $ | 0.06 |   |
| Earnings (loss)  per share - diluted                                                      |       | $                                | (0.12      | ) | $ | 0.06 |   |
|                                                                                      |       |                             |       |   |   |
| Antidilutive options  and warrants                                                        |       | 5,649                            |       | 3,355 |   |

 

**9.****              ConsolidatedComprehensive Income**

The followingtable presents the calculation of comprehensive income.  The components of comprehensive income forthe periods ended June 30 were as follows, in thousands:
|                                                                                        | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                             | ** ** | **June 30**                 | ** ** |
| ** **                                                                             | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Net (loss)  income                                                                     |       | $                                | (2,494     | ) | $ | 1,202 |   |
| Unrealized  (losses) gains on investments classified as available for sale, net of tax |       | (104                             | )          | 89 |   |
| Comprehensive  (loss) income                                                           |       | $                                | (2,598     | ) | $ | 1,291 |   |

 

**10.****       Segment Information**

The Company follows theprovisions of SFAS No. 131, *Disclosures about Segmentsof 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.

17

----

Operating segmentinformation for Mesaba, Big Sky and MAIR were as follows, in thousands:
| ** **                                                                                                                            | ** ** | **Mesaba** | ** ** | **Big Sky** | ** ** | **Holdings** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------------|------------|--------------|------------|------------------|------------|------------------|------------|
| *Three Months Ended June 30,  2006:*                                                                                                  | * *   | * *   | * *   | * *         | * *   | * *     | * *   | * *         | * *   | * *         | * *   |
| Operating  revenues                                                                                                                   |       | $          | 83,440     |             | $          | 6,043        |       | $                | 59         |             | $          | (83,499 | ) | $ | 6,043 |   |
| Operating  expenses                                                                                                                   |       | 85,075     |       | 6,663            |       | 3,233        |       | (85,134          | )          | 9,837            |       |
| Depreciation and  amortization                                                                                                        |       | 2,554      |       | 173              |       | 5            |       | (2,554           | )          | 178              |       |
| Interest expense                                                                                                                      |       | —     |       | 114              |       | —       |       | (97              | )          | 17               |       |
| Reorganization  items, net                                                                                                            |       | (1,828     | )          | —           |       | —       |       | 1,828            |       | —           |       |
| Income (loss)  before income taxes, equity in income/(loss) of Mesaba and Mesaba cumulative  effect of change in accounting principle |       | 593        |       | (732             | )          | (1,762       | )          | (593             | )          | (2,494           | )          |
| Capital  expenditures                                                                                                                 |       | 968        |       | 94               |       | —       |       | (968             | )          | 94               |       |
| At end of  period:                                                                                                                    |       |       |       |             |       |         |       |             |       |             |       |
| Current assets                                                                                                                        |       | 74,566     |       | 4,493            |       | 82,668       |       | (79,431          | )          | 82,296           |       |
| Total assets                                                                                                                          |       | 111,077    |       | 8,403            |       | 128,650      |       | (129,375         | )          | 118,755          |       |
| Current  liabilities                                                                                                                  |       | 47,034     |       | 9,866            |       | 6,925        |       | (51,900          | )          | 11,925           |       |
| Total  stockholders’ equity (deficit)                                                                                            |       | 3,024      |       | (2,177           | )          | 121,725      |       | (16,456          | )          | 106,116          |       |
| *Three Months Ended June 30,  2005:*                                                                                                  | * *   | * *   | * *   | * *         | * *   | * *     | * *   | * *         | * *   | * *         | * *   |
| Operating  revenues                                                                                                                   |       | $          | 110,143    |             | $          | 4,540        |       | $                | 1,496      |             | $          | (1,496 | ) | $ | 114,683 |   |
| Operating  expenses                                                                                                                   |       | 110,273    |       | 5,358            |       | 1,466        |       | (1,496           | )          | 115,601          |       |
| Depreciation and  amortization                                                                                                        |       | 3,578      |       | 220              |       | 4            |       | —           |       | 3,802            |       |
| Interest expense                                                                                                                      |       | —     |       | 65               |       | —       |       | (49              | )          | 16               |       |
| Income (loss)  before income taxes                                                                                                    |       | 74         |       | (880             | )          | 2,684        |       | —           |       | 1,878            |       |
| Capital  expenditures                                                                                                                 |       | 2,671      |       | 281              |       | 12           |       | —           |       | 2,964            |       |
| At end of  period:                                                                                                                    |       |       |       |             |       |         |       |             |       |             |       |
| Current assets                                                                                                                        |       | 71,925     |       | 3,361            |       | 114,961      |       | (2,949           | )          | 187,298          |       |
| Total assets                                                                                                                          |       | 116,545    |       | 11,488           |       | 163,583      |       | (12,882          | )          | 278,734          |       |
| Current  liabilities                                                                                                                  |       | 69,536     |       | 8,424            |       | 3,995        |       | (2,693           | )          | 79,262           |       |
| Total stockholders’  equity                                                                                                      |       | 41,988     |       | 2,267            |       | 159,588      |       | (9,851           | )          | 193,992          |       |

 

**11.****       Commitments andContingencies**

*SaabLeasing Litigation*On October 4, 2002, Fairbrook Leasing, Inc., Lambert Leasing,Inc. and Swedish Aircraft Holdings AB (“Saab Leasing”) filed a declaratoryjudgment action against Mesaba relating to 20 Saab 340A (“340A”) aircraftleased by Mesaba.  Saab Leasing sought a judicial declaration that theterms of the leases applicable to each of the 340A aircraft are governed by aMarch 7, 1996 term sheet proposal rather than the parties’ subsequentagreements and conduct.  In a December 8, 2003 order, the District Courtdeclared the term sheet proposal a binding preliminary agreement requiringMesaba to negotiate in good faith toward the execution of long-term agreementsfor each of the 340A aircraft.  Mesaba appealed the District Court’sruling.

On August 13, 2004,relying on the District Court’s declaratory judgment ruling, Saab Leasing fileda separate action in the District Court alleging approximately $35 million indamages for past due and future aircraft lease obligations.  Mesaba deniedthe allegations in Saab Leasing’s complaint and contended that it had fulfilledand would continue to fulfill its existing obligations.

On May 19, 2005, the U.S.Court of Appeals for the Eighth Circuit affirmed the District Court’sdeclaratory judgment ruling.  Despite the Eighth Circuit’s ruling, Mesababelieved, based on advice from its legal counsel, that it had defenses in thedamages case that limited Saab Leasing’s ability to recover damages.  OnSeptember 9, 2005, the District Court heard oral arguments on Saab Leasing’sand Mesaba’s cross-motions for summary judgment.  The District Court did not rule on thesemotions prior to Mesaba’s bankruptcy petition.

On October 14, 2005,Mesaba notified the District Court that Mesaba applied for debtor protectionunder Chapter 11 of the Bankruptcy Code and that such application operates toautomatically stay the continuation of the Saab Leasing matter.  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.  OnJuly 6, 2006, the District Court granted Mesaba’s motion for partial summaryjudgment, ruling that Saab Leasing is not eligible to receive damages for themajority of its claims against Mesaba. Because

18

----

the potential damages forthe remaining claim against Mesaba are not significant, Mesaba has notestablished any accrual with regard to this litigation within its condensedfinancial statements.

*OtherLitigation Matters*Mesaba is also a defendant in various lawsuits arising in theordinary 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 or the consolidated financialstatements of the Company as a whole. Additionally, any lawsuit filed against Mesaba prior to the PetitionDate is subject to the automatic stay. If and when these cases proceed, the amount of any damages award to theplaintiffs would be deemed unsecured prepetition claims against Mesaba.

*Guaranty*Mesaba currently leases a hangar facility at theCincinnati/Northern Kentucky International Airport.  MAIR has unconditionally guaranteed full andprompt payment of the bonds associated with the initial financing of thefacility.  In October 2005, following itsbankruptcy filing, Mesaba vacated the facility due to the reduced number ofAvros that will require maintenance in the future.  In accordance with its guaranty, MAIR hasbeen making the required ground and facilities lease payments of $0.1 millionper month since November 2005.  Additionally,on February 15, 2006, MAIR received notice that UMB Bank, N.A. (“UMB”), thetrustee for the bondholders, declared MAIR’s liability for all sums to beimmediately due and payable.  On April18, 2006, MAIR entered into an agreement with UMB under which UMB agreed toforbear acceleration of MAIR’s guarantee obligations in exchange for MAIRdelivering a letter of credit in the amount of $13.1 million to secure thepayment of the obligations owed by MAIR to UMB.

The letter of credit wasissued by First Interstate Bank of Billings and is currently fullycollateralized by MAIR’s cash account held at First Interstate Bank.  Under the agreement with UMB, MAIR isobligated to maintain the letter of credit until all obligations under thebonds are satisfied.  MAIR’s annualobligations with respect to the bonds and the ground lease for the facilitytotal approximately $1.2 million, and those obligations will continue throughJuly 2029 and will increase at scheduled intervals in accordance with the termsof the bond documents.  The UMB agreementand the letter of credit provide that the amount of the letter of credit willautomatically decrease each July in accordance with the redemption schedule forthe bonds.

UMB may draw on theletter of credit upon the occurrence of an event of default under its agreementwith MAIR, including if MAIR fails to make any payment when due to UMB, if MAIRfails to provide evidence that the letter of credit has been renewed annually(or if MAIR 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 MAIR fails to complywith the terms of its agreement with UMB or if MAIR commits any event ofdefault under its guaranty of Mesaba’s bond obligations.  MAIR recorded the cash supporting the letterof credit as “Restricted cash” on the Company’s consolidated balance sheeteffective April 18, 2006.

Because Mesaba vacatedthe hangar in October 2005 and MAIR is the guarantor of the facility, MAIR iscurrently seeking other sublessors to lease the facility.  As of June 30, 2006, MAIR established a$4.5 million accrual related to this guaranty, which assumes that the facilitywill remain vacant for the next two years, during which time MAIR will continueto make bond and lease payments, and that thereafter MAIR will be able tosublease the facility at a 20% discount. MAIR will reassess this reserve in future periods as materialdevelopments occur.

*OtherGuarantees*Mesaba has letters of credit to guarantee certain obligationsprincipally for workers’ compensation policies, airport leases and otherobligations, which totaled $4.6 million and $4.1 million as of June 30, 2006and March 31, 2006, respectively.  Therewere no amounts drawn on these letters of credit during fiscal 2006 or2005.  As collateral for these letters ofcredit, Mesaba had $4.7 million and $4.5 million in cash held in an investmentaccount as of June 30, 2006 and March 31, 2006, respectively.  This amount is restricted and has beenclassified within “Long-term investments” in Mesaba’s condensed balance sheets.

In February 2005,Big Sky obtained a revolving line of credit in the principal amount of $0.3million from First Interstate Bank of Billings. In March 2006, the principal amount available under the line increasedto $0.4 million.

19

----

The line of creditrequires a variable interest rate based on the prime rate published in the *Wall Street Journal*. At June 30, 2006, the rate was 8.25%. The line of credit is collateralized by Big Sky’s inventory, accountsreceivable and equipment and is scheduled to mature in January 2007.

**12.****       Restatement**

Subsequent to theissuance of its consolidated financial statements for the quarter ended June30, 2005, the Company’s management determined that two categories of pass-throughcosts under the ASA with Northwest were not presented in accordance withEmerging Issues Task Force (“EITF”) No. 99-19, *ReportingRevenue Gross as a Principal vs. Net as an Agent*, and EITF No.01-14, *Income Statement Characterization of ReimbursementsReceived for ‘Out-of-Pocket’ Expenses Incurred*.  First, the Company determined that certainlanding fees reimbursed by Northwest had not been recognized in the Company’sconsolidated statements of operations but should have been recorded as both operatingrevenue and operating expense in prior periods. Second, the Company determined that aircraft fuel purchased fromNorthwest for the Saabs and CRJs should have been shown as a reduction ofrevenue rather than as an operating expense in prior periods.  As a result of these misstatements, passengerrevenues, aircraft fuel expense and landing fees expense for the three monthsended June 30, 2005 have been restated from amounts previously reported.  The restatement had no effect on previouslyreported operating income, income before income taxes, net income, earnings pershare, net cash flows or the Company’s financial condition.

A summary of thesignificant effects of this restatement on the Company’s consolidatedstatements of operations for from the three month ended June 30, 2005 is asfollows, in thousands:
|                           | ** ** | **Three Months Ended** | ** ** |
|---------------------------|------------|----------------------------------|------------|
| ** **                | ** ** | **June 30, 2005**      | ** ** |
| ** **                | ** ** | **As Previously**           | ** ** | **As** | ** ** |
| ** **                | ** ** | **Reported**                     | ** ** | **Restated** | ** ** |
| Passenger  revenues       |       | $                                | 107,539    |   | $ | 103,783 |   |
| Total operating  revenues |       | 118,439                          |       | 114,683 |   |
| Aircraft fuel             |       | 5,658                            |       | 958 |   |
| Landing fees              |       | 1,676                            |       | 2,620 |   |
| Total operating  expenses |       | 119,357                          |       | 115,601 |   |
|                           |            |                                  |            |  |  |  |  |

 

**13.****       Financial Information ofMesaba**

The followingcondensed financial statements of Mesaba have been prepared in conformity withSOP 90-7, which requires that the liabilities subject to compromise by theBankruptcy Court be segregated from liabilities not subject to compromise andthat all transactions directly associated with the reorganization beidentified.  Liabilities subject tocompromise include prepetition unsecured claims that may be settled at amountsthat differ from those recorded in Mesaba’s condensed financial statements.

The financial informationis also prepared on a going concern basis, which contemplates the realizationof assets and the liquidation of liabilities in the ordinary course ofbusiness.  However, as a result of thebankruptcy filing, such realization of assets and liquidation of liabilities issubject to significant uncertainty.

As discussed in Note 1,MAIR has deconsolidated Mesaba, its wholly-owned subsidiary, from the Company’sJune 30, 2006 and March 31, 2006 consolidated balance sheets and theconsolidated statement of operations and cash flows since Mesaba’s bankruptcyfiling on October 13, 2005. MAIR’s investment in Mesaba is accounted for andreported using the equity method of accounting subsequent to the October 13,2005 deconsolidation date as required by GAAP and SEC guidance.  All of MAIR’s previously reportedconsolidated balance sheets, statements of operations and cash flows prior toOctober 13, 2005 continue to include Mesaba’s financial position, results ofoperations and cash flows.

20

----

**MESABAAVIATION, INC.(DEBTOR-IN-POSSESSION)CONDENSED BALANCE SHEETS(in thousands)(Unaudited)**
| ** **                                                   | ** ** | **June 30** | ** ** | **March 31** | ** ** |
|--------------------------------------------------------------|------------|------------------|------------|-------------------|------------|
| ** **                                                   | ** ** | **2006**         | ** ** | **2006**          | ** ** |
| ASSETS                                                       |       |             |       |              |       |
|                                                         |       |             |       |              |       |
| CURRENT ASSETS:                                              |       |             |       |              |       |
| Cash and cash  equivalents                                   |       | $                | 19,420     |              | $          | 20,718 |   |
| Short-term  investments                                      |       | 4,126            |       | 3,262             |       |
| Restricted cash                                              |       | 6,847            |       | 6,782             |       |
| Accounts  receivable, net of reserves of $29,818 and $29,755 |       | 26,907           |       | 29,181            |       |
| Income taxes  receivable                                     |       | 3,288            |       | 3,288             |       |
| Inventories, net                                             |       | 7,936            |       | 9,001             |       |
| Prepaid expenses  and deposits                               |       | 5,791            |       | 5,998             |       |
| Intercompany  receivable from MAIR Holdings, Inc.            |       | 251              |       | 54                |       |
| Total current  assets                                        |       | 74,566           |       | 78,284            |       |
|                                                         |       |             |       |              |       |
| PROPERTY AND EQUIPMENT:                                      |       |             |       |              |       |
| Flight equipment                                             |       | 93,995           |       | 95,357            |       |
| Other property  and equipment                                |       | 41,726           |       | 41,373            |       |
| Less: Accumulated  depreciation and amortization             |       | (105,774         | )          | (104,198          | )          |
| Net property and  equipment                                  |       | 29,947           |       | 32,532            |       |
|                                                         |       |             |       |              |       |
| NONCURRENT ASSETS:                                           |       |             |       |              |       |
| Long-term  investments                                       |       | 5,755            |       | 6,761             |       |
| Other assets,  net                                           |       | 809              |       | 864               |       |
|                                                         |       | $                | 111,077    |              | $          | 118,441 |   |
|                                                         |       |             |       |              |       |
| LIABILITIES AND  SHAREHOLDER’S EQUITY                   |       |             |       |              |       |
|                                                         |       |             |       |              |       |
| CURRENT LIABILITIES:                                         |       |             |       |              |       |
| Accounts payable                                             |       | $                | 8,148      |              | $          | 8,638 |   |
| Accrued  liabilities:                                        |       |             |       |              |       |
| Payroll                                                      |       | 16,101           |       | 14,666            |       |
| Maintenance                                                  |       | 10,775           |       | 17,250            |       |
| Deferred income                                              |       | 3,003            |       | 2,962             |       |
| Other current  liabilities                                   |       | 9,007            |       | 9,468             |       |
| Total current  liabilities                                   |       | 47,034           |       | 52,984            |       |
|                                                         |       |             |       |              |       |
| OTHER NONCURRENT  LIABILITIES                                |       | 1,921            |       | 2,547             |       |
| Total  liabilities not subject to compromise                 |       | 48,955           |       | 55,531            |       |
|                                                         |       |             |       |              |       |
| LIABILITIES SUBJECT TO  COMPROMISE (A)                       |       | 59,098           |       | 59,973            |       |
| Total  liabilities                                           |       | 108,053          |       | 115,504           |       |
|                                                         |       |             |       |              |       |
| COMMITMENTS AND  CONTINGENCIES (Note 11)                     |       |             |       |              |       |
|                                                         |       |             |       |              |       |
| SHAREHOLDER’S EQUITY:                                   |       |             |       |              |       |
| Paid-in capital                                              |       | 48,255           |       | 48,255            |       |
| Accumulated  other comprehensive loss                        |       | (12              | )          | (13               | )          |
| Accumulated  deficit                                         |       | (45,219          | )          | (45,305           | )          |
| Total  shareholder’s equity                             |       | 3,024            |       | 2,937             |       |
|                                                         |       | $                | 111,077    |              | $          | 118,441 |   |

21

----

**MESABAAVIATION, INC.(DEBTOR-IN-POSSESSION)CONDENSED STATEMENTS OF OPERATIONS(in thousands)(Unaudited)**
| ** **                                                                          | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                          | ** ** | **June 30**                 | ** ** |
| ** **                                                                          | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| OPERATING  REVENUES:                                                                |       |                             |       |   |   |
| Passenger                                                                           |       | $                                | 75,499     |   | $ | 101,280 |   |
| Freight and other                                                                   |       | 7,941                            |       | 8,863 |   |
| Total operating revenues                                                            |       | 83,440                           |       | 110,143 |   |
|                                                                                |       |                             |       |   |   |
| OPERATING  EXPENSES:                                                                |       |                             |       |   |   |
| Wages and benefits                                                                  |       | 33,489                           |       | 37,291 |   |
| Aircraft maintenance                                                                |       | 15,377                           |       | 22,053 |   |
| Aircraft rents                                                                      |       | 17,405                           |       | 25,236 |   |
| Landing fees                                                                        |       | 2,163                            |       | 2,547 |   |
| Insurance and taxes                                                                 |       | 1,097                            |       | 1,667 |   |
| Depreciation and amortization                                                       |       | 2,554                            |       | 3,578 |   |
| Administrative and other                                                            |       | 12,990                           |       | 17,901 |   |
| Total operating expenses                                                            |       | 85,075                           |       | 110,273 |   |
| Operating loss                                                                      |       | (1,635                           | )          | (130 | ) |
|                                                                                |       |                             |       |   |   |
| NONOPERATING  INCOME:                                                               |       |                             |       |   |   |
| Interest income and other                                                           |       | 400                              |       | 204 |   |
| Reorganization items, net (B)                                                       |       | 1,828                            |       | — |   |
| Nonoperating income, net                                                            |       | 2,228                            |       | 204 |   |
| Income before income taxes and cumulative effect of  change in accounting principle |       | 593                              |       | 74 |   |
|                                                                                |       |                             |       |   |   |
| PROVISION FOR  INCOME TAXES                                                         |       | —                           |       | (16 | ) |
|                                                                                |       |                             |       |   |   |
| INCOME BEFORE  CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE                  |       | 593                              |       | 58 |   |
|                                                                                |       |                             |       |   |   |
| CUMULATIVE  EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (Note 7)                       |       | (507                             | )          | — |   |
| NET INCOME                                                                          |       | $                                | 86         |   | $ | 58 |   |

22

----

**MESABAAVIATION, INC.(DEBTOR-IN-POSSESSION)CONDENSED STATEMENTS OF CASH FLOWS(in thousands)(Unaudited)**
| ** **                                                                                   | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                   | ** ** | **June 30**                 | ** ** |
| ** **                                                                                   | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                       |       |                             |       |   |   |
| Net income                                                                                   |       | $                                | 86         |   | $ | 58 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities: |       |                             |       |   |   |
| Depreciation and amortization                                                                |       | 2,554                            |       | 3,578 |   |
| Amortization of deferred credits                                                             |       | (626                             | )          | (346 | ) |
| Deferred income taxes                                                                        |       | —                           |       | 183 |   |
| Cumulative effect of change in accounting principle                                          |       | 507                              |       | — |   |
| Changes in current operating items:                                                          |       |                             |       |   |   |
| Accounts receivable                                                                          |       | 2,274                            |       | 4,164 |   |
| Inventories                                                                                  |       | 1,065                            |       | (705 | ) |
| Prepaid expenses and deposits                                                                |       | 207                              |       | 19 |   |
| Accounts payable and other                                                                   |       | (2,855                           | )          | (4,003 | ) |
| Net cash provided by operating activities before  reorganization items                       |       | 3,212                            |       | 2,948 |   |
|                                                                                         |       |                             |       |   |   |
| CASH FLOWS FROM  REORGANIZATION ACTIVITIES:                                                  |       |                             |       |   |   |
| Reorganization items, net                                                                    |       | 1,828                            |       | — |   |
| Decrease in damage claims                                                                    |       | (991                             | )          | — |   |
| Impairment of property and equipment                                                         |       | 996                              |       | — |   |
| Reversal of accrued maintenance                                                              |       | (5,176                           | )          | — |   |
| Net cash used in reorganization activities                                                   |       | (3,343                           | )          | — |   |
| Net cash (used in) provided by operating activities                                          |       | (131                             | )          | 2,948 |   |
|                                                                                         |       |                             |       |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                       |       |                             |       |   |   |
| Purchases of investments                                                                     |       | (263                             | )          | (617 | ) |
| Sales of investments                                                                         |       | 426                              |       | — |   |
| Increase in restricted cash                                                                  |       | (65                              | )          | — |   |
| Purchases of property and equipment                                                          |       | (968                             | )          | (2,671 | ) |
| Net cash used in investing activities                                                        |       | (870                             | )          | (3,288 | ) |
|                                                                                         |       |                             |       |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES                                                        |       |                             |       |   |   |
| Increase in intercompany receivable from MAIR  Holdings, Inc.                                |       | (197                             | )          | 16 |   |
| Debt issuance costs                                                                          |       | (100                             | )          | — |   |
| Net cash (used in) provided by financing activities                                          |       | (297                             | )          | 16 |   |
|                                                                                         |       |                             |       |   |   |
| NET DECREASE IN  CASH AND CASH EQUIVALENTS                                                   |       | (1,298                           | )          | (324 | ) |
|                                                                                         |       |                             |       |   |   |
| CASH AND CASH  EQUIVALENTS:                                                                  |       |                             |       |   |   |
| Beginning of period, excluding restricted cash and  cash equivalents                         |       | 20,718                           |       | 20,357 |   |
| End of period,  excluding restricted cash and cash equivalents                               |       | $                                | 19,420     |   | $ | 20,033 |   |

 

23

----

**MesabaAviation, Inc.(Debtor-in-Possession)Notes to Condensed Financial Statements**

**(A)****       Liabilities Subject toCompromise**

Liabilities subject tocompromise in Mesaba’s condensed balance sheet at June 30, 2006 and March 31,2006 refers to both secured and unsecured obligations that will be accountedfor under a plan of reorganization, including claims incurred prior to thepetition date.  They represent theestimated amount expected to be allowed on known or potential claims to beresolved through the Chapter 11 bankruptcy process and remain subject to futureadjustments arising from negotiated settlements, actions of the BankruptcyCourt, rejection of executory contracts and unexpired leases, the determinationas to the value of any collateral securing claims, proofs of claim or otherevents.

Mesaba has endeavored tonotify all of its known or potential creditors whose claims are subject toMesaba’s Chapter 11 case.  Subject tocertain exceptions under the Bankruptcy Code, Mesaba’s Chapter 11 filingautomatically stayed the continuation of any judicial or administrativeproceedings or other actions against Mesaba or its property to recover, collector secure a claim arising prior to the Petition Date.  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 hasestimated the value of the claims that will be allowed by the Bankruptcy Courtat $59.1 million, the Bankruptcy Court will make the final determinationregarding what portion of the $216.8 million in total proofs of claim filedwill be deemed allowable claims.  Thedetermination of how those liabilities will ultimately be treated will not beknown until the Bankruptcy Court approves a plan of reorganization and theclaims resolution process is complete, which may occur well after aconfirmation of a plan of reorganization. Mesaba will continue to evaluate the amounts of these liabilitiesthrough the remainder of the Chapter 11 process.  Mesaba will continue to recognize anyadditional amounts subject to compromise that it identifies in the future.  As a result, the amounts of liabilitiessubject to compromise are likely to change.

Liabilitiessubject to compromise at June 30, 2006 and March 31, 2006 were as follows, inthousands:

|                                         | ** ** | **June 30** | ** ** | **March 31** | ** ** |
|-----------------------------------------|------------|------------------|------------|-------------------|------------|
| ** **                              | ** ** | **2006**         | ** ** | **2006**          | ** ** |
| Accounts payable  and other liabilities |       | $                | 34,061     |              | $          | 34,936 |   |
| Damage claims                           |       | 20,066           |       | 20,066            |       |
| Secured claims                          |       | 2,520            |       | 2,520             |       |
| Priority tax  claims                    |       | 2,451            |       | 2,451             |       |
|                                    |       | $                | 59,098     |              | $          | 59,973 |   |

 

**(B)****       Reorganization Items**

Reorganization itemsrecorded from the Petition Date through June 30, 2006 consisted of transactionsand events that were directly associated with the reorganization ofMesaba.  The reorganization activityincluded aircraft impairment and other rejection charges, legal andprofessional fees to support the restructuring process and the write-off ofmaintenance accruals.  The charge fordamage claims results from estimated claims as a result of Mesaba’s rejectionor renegotiation of certain aircraft and other leases and obligations as partof the bankruptcy process.

24

----

Net reorganization itemsfor the three months ended June 30, 2006 were as follows, in thousands:
| Settlement of damage claim            |   | $      | (991   | ) |
|---------------------------------------|--------|--------|--------|---|
| Legal and  professional fees          |   | 3,343  |   |
| Impairment of  property and equipment |   | 996    |   |
| Reversal of  accrued maintenance      |   | (5,176 | )      |
|                                  |   | $      | (1,828 | ) |

 

**ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

*General*Management’s Discussion and Analysis of Financial Conditionand Results of Operations has been updated to give effect to the restatementdiscussed in Note 12 to the condensed consolidated financial statementsincluded in Item 1,  and should be readin conjunction with the accompanying condensed consolidated financialstatements.  The Company’s operations andfinancial results are subject to various risks and uncertainties associatedwith the airline industry.  See “RiskFactors” in Item 1A of Part II.

*Overview*

MesabaSince Mesaba filed for bankruptcy on October 13, 2005 it hasbeen focused on restructuring its labor and non-labor expenses to calibrate itscost structure to a fleet of 49 Saabs, which Northwest has dictated via its ownbankruptcy.  Mesaba intends to use thebankruptcy process to return to profitability as a smaller, competitivelow-cost supplier of regional flights. Specifically, it intends to:

·                  Downsize its operations to adjust tothe smaller fleet;

·                  Reduce its labor expenses by 19.4%;and

·                  Lowerits fixed expenses by 43%.

*FleetReduction*Since its bankruptcy filing, Northwest hasimplemented various changes to Mesaba’s fleet. Between September 14, 2005 and July 15, 2006, Northwest removed 19Avros, 13 Saabs and one CRJ.  Mesabaanticipates that Northwest will terminate all the remaining aircraft, otherthan 49 Saabs, by the end of calendar 2006, subject to final lease negotiationsbetween Northwest and its lessors.  As ofJuly 31, 2006, Mesaba was operating 13 Avros, 50 Saabs and one CRJ pursuant tothe ASA.

*LaborCosts Restructuring.*Mesaba is working to achieve its targetof a 19.4% reduction in annual labor costs through a combination of agreementsnegotiated with its employee labor groups and pay and benefit reductions fromits management and hourly non-union employees. On January 31, 2006, the Bankruptcy Court approved the tentativeagreement reached between Mesaba and its dispatchers for the necessaryreductions for a portion of its labor expenses.

The Bankruptcy Codeprovides special treatment for collective bargaining agreements (“CBAs”). Inparticular, Section 1113(c) of the Bankruptcy Code permits Mesaba to move toreject its CBAs if Mesaba first satisfies a number of statutorily prescribedsubstantive and procedural prerequisites and obtains the Bankruptcy Court’sapproval of the rejection or the expiration of the statutorily prescribed timeperiod. After bargaining in good faith and sharing relevant information with itsunions, a debtor must make proposals to modify its existing CBAs based on themost complete and reliable information available at the time. The proposedmodifications must be necessary to permit the reorganization of a debtor andmust provide that all the affected parties are treated fairly and equitably.Ultimately, rejection of the CBAs is appropriate if the unions refuse to agreeto a debtor’s necessary proposal “without good cause” and the Bankruptcy Courtdetermines that the balance of the equities favors rejection. In February 2006,Mesaba commenced Section 1113(c) proceedings with unions for its pilots, flightattendants and mechanics.  On July 14,2006, the Bankruptcy Court granted Mesaba’s motion to reject its CBAs, butrequired that

25

----

Mesaba provide ten days’notice before it imposes new contract terms on its unions.  Mesaba remains committed to reachingconsensual labor agreements with each of its unions and is currently innegotiations with all three unions.

*Non-labor Cost Restructuring*.  Mesaba plans to achieve non-labor costreductions by eliminating excess facilities, eliminating Avro-related expenses,reducing vendor costs and reducing infrastructure to reflect the smaller fleet.

Big SkyBig Sky has focused on growing its Beechcraft 1900D operationby bidding on additional EAS flying and seeking other opportunities to expandits fleet.  Specifically, it has expandedits Boise operation, serving Billings, Bozeman and Missoula, Montana,Pocatello, Idaho, Moses Lake and Walla Walla, Washington and Jackson Hole,Wyoming.   It has also reached agreementto start a capacity purchase operation in Florida, beginning with twoBeechcraft 1900D aircraft in the fall of 2006. Although higher fuel expenses have impacted the profitability of Big Sky’soperation, Big Sky will continue throughout the fiscal year to explore ways toexpand its operation and attempt to become profitable.

MAIRSeparately, MAIR will continue to explore additional growthopportunities in fiscal 2007 and will consider acquisitions to diversify bothwithin and outside the airline industry.

**RESULTS OF OPERATIONS**

**ThreeMonths Ended June 30, 2006 and 2005**The Company reported a consolidated net loss of $2.5million or $0.12 per basic and diluted share for the quarter ended June 30,2006, compared to net income of $1.2 million or $0.06 per diluted share for thequarter ended June 30, 2005.  To allowfor a more direct and meaningful comparison, Mesaba’s results of operationshave been analyzed for the three months ended June 30, 2006 and 2005 excludingthe deconsolidation of Mesaba from the Company’s consolidated financialstatements as of October 13, 2005, the date of Mesaba’s bankruptcy filing.  Mesaba’s condensed financial statements on astand-alone basis are presented in Note 13 of the accompanying Notes toCondensed Consolidated Financial Statements.

*Mesaba*

Mesaba OperatingRevenuesTotal operating revenues decreased 24.2% in the first quarterof fiscal 2007 to $83.4 million from $110.1 million in the prior yearquarter.  The decrease was due primarilyto a 20.6% reduction in Saab aircraft from 63 in the first quarter of fiscal2006 to 50 in the first quarter of 2007 and a 19 aircraft reduction in Avroaircraft from 35 in the first quarter of fiscal 2006 to 16 at the end of thefirst quarter of fiscal 2007. These reductions were offset by the addition oftwo CRJ aircraft in October 2005. As a result of these fleet reductions, SaabASMs and Avro revenue block hours were significantly lowerquarter-over-quarter. These decreases in revenue drivers for the Saab and Avrofleets reduced revenue by $9.5 million and $20.0 million, respectively,quarter-over-quarter. These reductions were offset slightly by CRJ revenues of$3.1 million.

Mesaba OperatingExpensesTotal operating expenses decreased 22.9% to $85.1 million inthe first quarter of fiscal 2007 from $110.3 million in the prior yearquarter.  The cost per ASM increased16.0% to 16.8 cents in the first quarter of fiscal 2007 from 14.4 cents in theprior year quarter.  The following tablecompares components of operating cost per ASM for the three months ended June30:

26

----

 
| ** **                     | ** ** | **Operating Expenses**      | ** ** | **Operating Cost Per ASM** | ** ** |
|--------------------------------|------------|----------------------------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **Three Months Ended** | ** ** | ** **                                | ** ** | **Three Months Ended** | ** ** |
| ** **                     | ** ** | **June 30**                 | ** ** | ** **                                | ** ** | **June 30** | ** ** |
| ** **                     | ** ** | **2006**                         | ** ** | **2005**                                  | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Wages and benefits             |       | $                                | 33,489     |                                      | $          | 37,291 |   | $ | (3,802 | ) | (10.2 | )% | 6.7 | ¢ | 4.9 | ¢ |
| Aircraft  maintenance          |       | 15,377                           |       | 22,053                                    |       | (6,676 | ) | (30.3 | )% | 3.0 |   | 2.9 |   |
| Aircraft rents                 |       | 17,405                           |       | 25,236                                    |       | (7,831 | ) | (31.0 | )% | 3.4 |   | 3.3 |   |
| Landing fees                   |       | 2,163                            |       | 2,547                                     |       | (384 | ) | (15.1 | )% | 0.4 |   | 0.3 |   |
| Insurance and taxes            |       | 1,097                            |       | 1,667                                     |       | (570 | ) | (34.2 | )% | 0.2 |   | 0.2 |   |
| Depreciation and  amortization |       | 2,554                            |       | 3,578                                     |       | (1,024 | ) | (28.6 | )% | 0.5 |   | 0.5 |   |
| Administrative  and other      |       | 12,990                           |       | 17,901                                    |       | (4,911 | ) | (27.4 | )% | 2.6 |   | 2.3 |   |
|                           |       | $                                | 85,075     |                                      | $          | 110,273 |   | $ | (25,198 | ) | (22.9 | )% | 16.8 | ¢ | 14.4 | ¢ |

 

Wages and benefitsdecreased 10.2% to $33.5 million in the first quarter of fiscal 2007 from $37.3million in the prior year quarter.  Wagesand benefits were lower primarily due to necessary reduction to personnel levelsto accommodate the reduced fleet levels. More specifically, pilots’ wages decreased 16.8%, or $1.9 million;flight attendants’ wages decreased 20.7%, or $0.6 million; mechanics’ wagesdecreased 16.2%, or $0.4 million; and all other wages decreased 5.4%, or $0.7million. Taxes and benefits decreased proportionately with wages.

Aircraft maintenancecosts, excluding wages and benefits, decreased 30.3% to $15.4 million in thefirst quarter of fiscal 2007 from $22.1 million in the prior year quarter.  The reduction in maintenance expense was drivenby a $5.3 million decrease in Avro maintenance due to the reduced fleet andreturn agreements with Northwest on the remaining Avro that require a specifiedmaintenance rate per aircraft take off and landing.  The maintenance expense decrease is also dueto a $1.5 million reduction in Saab maintenance expense due to the reducedfleet.

Aircraft rents decreased31.0% to $17.4 million in the first quarter of fiscal 2007 from $25.2 millionin the prior year quarter.  The decreasewas due to the reduction in Saab and Avro aircraft quarter-over-quarter.  These reductions were offset by the additionof two CRJ aircraft in October 2005.

Landing feesdecreased 15.1% to $2.2 million in first quarter of fiscal 2007 from $2.5million in the prior year quarter due to reduced flying.  Total landing fee expense was down $0.1million for the Saab fleet and $0.4 million for the Avro fleet. CRJ landingfees were $0.1 million for first quarter of fiscal 2007. Although Northwest isresponsible for the Avro landing fees for Mesaba’s operations, Mesaba paysseveral airports directly, and Northwest reimburses Mesaba for suchpayments.  The reimbursement fromNorthwest for these Avro landing fees was $0.6 million and $0.9 million for thequarters ended June 30, 2006 and 2005, respectively, and is recorded as bothlanding fees expense and passenger revenue in Mesaba’s condensed statements ofoperations.

Insurance and taxesdecreased 34.2% to $1.1 million in the first quarter of fiscal 2007 from $1.7million in the prior year quarter.   The reduction in insurance and taxes is due tolower hull passenger insurance due to reduced rates, the smaller fleet size anda reduced number of passengers.

Depreciation andamortization decreased 28.6% to $2.6 million in the first quarter of fiscal 2007compared to $3.6 million in the prior year quarter.  The reduced depreciation expense is due toreduced capital spending over the last several years and reduced purchases ofrotable and repairable parts due to the reduced fleet size.

Administrative and otherexpenses decreased 27.4% to $13.0 million in first quarter of fiscal 2007 from$17.9 million in prior year. Administrative and other expense is down primarily due to the MAIRmanagement fee in the first quarter of fiscal 2006 of $1.4 million, which wasnot incurred in the first quarter of fiscal 2007. Additionally, from the firstquarter of fiscal 2006 to the first quarter of fiscal 2007, there was areduction in Avro-related items, including travel and hotel, training andground handling costs of $2.0 million. Also, in the first quarter of fiscal 2006, Mesaba recorded consultingfees of $1.0 million in connection with the certification of the CRJ.

Mesaba is in the processof reorganizing in an attempt to exit bankruptcy. In the first quarter of fiscal2007, Mesaba recorded a $1.8 million credit to reorganization items. Thesereorganization items included $2.0 million of legal fees, $1.3 million ofoutside consultant costs and $1.0 million of fixed asset write-offs, offset bythe reversal of $5.2 million in maintenance related accruals and a $1.0 millionwaived damage claim.

27

----

Mesaba incurred fuelexpenditures of $4.1 million, or 0.8 cents per ASM, in the first quarter offiscal 2007, compared to $4.7 million or 0.8 cents per ASM in the first quarterof fiscal 2006.  In accordance with EITFIssue No. 99-19, *Reporting Revenue Gross as a Principal vs.Net as an Agent*, these costs are classified as a reduction fromrevenue in Mesaba’s condensed statements of operations.  Aircraft fuel decreased due to decreasedflying.   Mesaba’s actual cost of fuelfor the Saab aircraft, including taxes and pumping fees, was 83.5 cents pergallon for both periods.  Mesaba’s actualcost of fuel for the CRJs, including taxes and pumping fees, was 70 cents pergallon for both periods.  These pricesare fixed under the terms of the ASA, thereby insulating Mesaba fromfluctuations in the market price of fuel. Northwest is responsible for all fuel for Mesaba’s Avro operations.

*Big Sky*

Big Sky OperatingRevenuesTotal operating revenuesincreased 33.1% to $6.0 million in first quarter of fiscal 2007 from $4.5million in the prior year quarter as a result of a 21.3% increase in blockhours flown, a 25.3% increase in average fare and a 12.8% increase in EASsubsidies.

Fiscal2007 included new service to Bozeman, Montana, Jackson Hole, Wyoming,Pocatello, Idaho and Walla Walla, Washington. The additional EAS subsidy revenue is the result of a contract renewalfor seven locations in Montana at higher rates per departure.

Big Sky OperatingExpensesTotal operating expensesin the first quarter of fiscal 2007 increased 24.4% to $6.7 million from $5.4million in the prior year, primarily due to increased flying year-over-year andthe associated costs of four additional cities. In fiscal 2007, Big Sky experienced a 51.5% increase in fuel expense,partially due to an increase in the average price of jet fuel, from $2.10 pergallon for the first quarter of fiscal 2006 to $2.57 per gallon in the firstquarter of fiscal 2007.
| ** **                     | ** ** | **Operating Expenses**      | ** ** | **Operating Cost Per ASM** | ** ** |
|--------------------------------|------------|----------------------------------|------------|-------------------------------------------|------------|
| ** **                     | ** ** | **Three Months Ended** | ** ** | ** **                                | ** ** | ** ** | ** ** | **Three Months Ended** | ** ** |
| ** **                     | ** ** | **June 30**                 | ** ** | ** **                                | ** ** | ** ** | ** ** | **June 30** | ** ** |
| ** **                     | ** ** | **2006**                         | ** ** | **2005**                                  | ** ** | **$ Change** | ** ** | **% Change** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Wages and  benefits            |       | $                                | 2,137      |                                      | $          | 1,572 |   | $ | 565 |   | 35.9 | % | 9.6 | ¢ | 9.2 | ¢ |
| Aircraft fuel                  |       | 1,451                            |       | 958                                       |       | 493 |   | 51.5 | % | 6.5 |   | 5.6 |   |
| Aircraft  maintenance          |       | 911                              |       | 718                                       |       | 193 |   | 26.9 | % | 4.1 |   | 4.2 |   |
| Aircraft rents                 |       | 453                              |       | 429                                       |       | 24 |   | 5.6 | % | 2.0 |   | 2.5 |   |
| Landing fees                   |       | 95                               |       | 73                                        |       | 22 |   | 30.1 | % | 0.4 |   | 0.4 |   |
| Insurance and  taxes           |       | 103                              |       | 78                                        |       | 25 |   | 32.1 | % | 0.5 |   | 0.5 |   |
| Depreciation and  amortization |       | 173                              |       | 220                                       |       | (47 | ) | (21.4 | )% | 0.8 |   | 1.3 |   |
| Administrative  and other      |       | 1,340                            |       | 1,310                                     |       | 30 |   | 2.3 | % | 6.0 |   | 7.6 |   |
|                           |       | $                                | 6,663      |                                      | $          | 5,358 |   | $ | 1,305 |   | 24.4 | % | 29.9 | ¢ | 31.3 | ¢ |

 

*MAIR*

MAIR OperatingExpensesTotal operating expenses in the first quarter of fiscal 2007increased to $3.2 million from $1.5 million in the prior year quarter primarilydue to increased legal, professional and accounting fees of $1.3 million,increased insurance costs of $0.4 million and $0.2 million in bank chargesrelated to the letter of credit supporting MAIR’s guaranty of Mesaba’sobligations for the Cincinnati/Northern Kentucky International Airport hangar.

*ConsolidatedOperating Loss*Operating losses for the first quarter in fiscal 2007increased to $3.8 million from $0.9 million in the prior year quarter.

*ConsolidatedNonoperating Income*Nonoperating income (net) decreased to $1.3 million in thefirst quarter of fiscal 2007 from $2.8 million in the prior year quarter.  The decrease was primarily due to a $1.8million arbitration settlement with an investment advisor in

28

----

the prior yearquarter, partially offset by increased interest income of $0.3 millionresulting from higher interest rates.

*ConsolidatedProvision for Income Taxes*There was no provision for income taxes in the first quarterof fiscal 2007 compared a provision for income taxes of $0.7 million in theprior year quarter. A valuation allowance was booked against the tax benefit inthe first quarter of 2007.   The Companyadjusts its effective tax rate quarterly based on forecasted results for thefiscal year.    The Company continues torecord a valuation allowance against its deferred tax assets due to theuncertainty regarding the ultimate realization of those assets. Therefore, theCompany’s net loss in the first quarter of fiscal 2007 was not reduced by anytax benefit.

**Liquidityand Capital Resources**

*Overview*Unrestricted cash, cash equivalents and investments decreased14.3% to $94.9 million at June 30, 2006 from $110.7 million at March 31, 2006,primarily due to recording restricted cash of $13.1 million for MAIR’sestablishment of a letter of credit supporting MAIR’s guaranty of Mesaba’sobligations for the hangar at the Cincinnati/Northern Kentucky InternationalAirport.  The Company’s working capitaldecreased to $70.4 million at June 30, 2006 compared to working capital of$85.9 million at March 31, 2006.

Approximately $24.0million, or 89.2%, of Mesaba’s net accounts receivable balance as of June 30,2006 was due from Northwest.  The Northwest receivables consisted of $7.3million in prepetition receivables as a result of offsetting prepetitionliabilities, and $16.7 million in post petition amounts due fromNorthwest.  As of July 31, 2006 Mesaba had collected $16.3 million of theJune 30, 2006 postpetition balance from Northwest.  Although Northwest has been payingpostpetition receivables due to Mesaba in the ordinary course of business sinceNorthwest’s bankruptcy, Mesaba’s business is sensitive to events and risksaffecting Northwest.  See previous bankruptcy discussions in Note 2 andrisks related to Northwest and Northwest’s bankruptcy in Part II, Item 1A “RiskFactors.”  Mesaba’s future liquidity will depend on the outcome of itslabor negotiations, obtaining debtor-in-possession financing and thereorganization plan it adopts, among other items.

*Cash Flows*Big SkyCash flows (used in) provided by activities at Big Sky were $(1.5) millionfor operating activities, $(0.1) million for investing activities and $1.6million from financing activities.

A summary of cash flowactivity at MAIR and Mesaba is presented below.

*OperatingActivities*

ConsolidatedNet cash used in operating activities for the three monthsended June 30, 2006 was $3.1 million, primarily due to a net loss of $2.5million, a decrease in accounts payable and other of $0.9 million and an increaseof $0.3 million in inventories.  Theseuses of cash were offset by a decrease in prepaid expenses of $0.6 million.

MesabaNet cash provided by operating activities before reorganizationitems for the three months ended June 30, 2006 was $3.2 million, primarily dueto depreciation and amortization of $2.6 million, decreases in accountsreceivable of $2.3 million and inventories of $1.1 million, offset by a decreasein accounts payable and other of $2.9 million.

*ReorganizationActivities*

MesabaNet cash used in reorganization activities for the threemonths ended June 30, 2006 was $3.3 million, primarily for legal andprofessional fees incurred related to Mesaba’s bankruptcy and reorganization.

29

----

 

*InvestingActivities*

Consolidated

Net cash used ininvesting activities for the three months ended June 30, 2006 was $18.9million.  The primary use of cash was forMAIR’s establishment of a $13.1 million letter of credit supporting MAIR’sguaranty of Mesaba’s obligations for the hangar at the Cincinnati/NorthernKentucky International Airport and net purchases of investments of $5.8million.

Mesaba

Net cash used ininvesting activities for the three months ended June 30, 2006 was $0.9million.  The primary use of cash was forthe purchase of property and equipment for $1.0 million, offset by $0.2 millionin net sales of investments.

*FinancingActivities*

Consolidated

Net cash provided byfinancing activities for the three months ended June 30, 2006 was $0.2 millionprimarily for MAIR’s intercompany payable to Mesaba for an insurance settlementreceived at MAIR.

Mesaba

Net cash used byfinancing activities for the three months ended June 30, 2006 was $0.3 million,consisting of $0.2 million for Mesaba’s receivable from MAIR for an insurancesettlement received at MAIR and $0.1 million for a commitment fee for potentialdebtor-in-possession financing.

*Outlook*

Consolidated

The Company hashistorically relied on cash and cash equivalents, investments and internallygenerated funds to support its working capital requirements.  Absent adverse factors outside the control ofthe Company, management believes current liquidity and funds from operationswill provide adequate resources for meeting the Company’s obligations throughthe end of fiscal 2007.

Mesaba

As Mesaba downsizes itsfleet to a Saab-only operation, its reorganization plan will requiresignificant reductions in labor and non-labor expenses.  Mesaba has also received a commitment fromMarathon to provide debtor-in-possession financing; however, this commitment issubject to certain conditions, including Mesaba reaching a resolution with itslabor unions.  If Mesaba is unable tomeet the conditions to receive funds pursuant to its debtor-in-possessionfinancing or is otherwise unable to generate sufficient cash for itsreorganization by the end of the second quarter of fiscal 2007, Mesaba could beforced into liquidation.

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

The preparation of theCompany’s consolidated financial statements and Mesaba’s stand-alone condensedfinancial statements in conformity with generally accepted accountingprinciples requires the use of estimates, judgments and assumptions that affectthe reported amounts of assets and liabilities as of the date of the condensedconsolidated financial statements, revenues and expenses during the reportingperiod and related disclosures of contingent assets and liabilities in thecondensed consolidated financial statements and the accompanying notes.  The SEC has defined a company’s most criticalaccounting policies as the ones that are most important to the portrayal of thecompany’s financial condition and results, and which require the company tomake its most difficult and subjective judgments, often as a result of the needto make estimates of matters that are inherently uncertain.  Based on this definition, the Company and itssubsidiaries have identified their critical accounting policies to includethose discussed in the following paragraphs. The Company and its subsidiaries also have other key accounting policiesthat involve the use of estimates, judgments and assumptions.

Mesaba’scondensed financial statements have been prepared in accordance with Statementof Position 90-7, *Financial Reporting byEntities in Reorganization Under the Bankruptcy Code* (“SOP 90-7”),and on a going

30

----

 

concernbasis, which contemplates continuity of operations, realization of assets andliquidation of post-petition liabilities in the ordinary course ofbusiness.  In accordance with SOP 90-7, the financial statements for theperiods presented distinguish transactions and events that are directlyassociated with the reorganization from the ongoing operations of theCompany.  While operating as a debtor-in-possession under the protectionof Chapter 11 of the Bankruptcy Code, in some cases, Mesaba may sell orotherwise dispose of assets, or liquidate and settle liabilities, for amountsother than those reflected in the condensed financial statements, subject tothe approval of the Bankruptcy Court or otherwise as permitted in the ordinarycourse of business.  Further, a plan of reorganization could materiallychange the amounts and classifications in the historical financial statements.

Management believes thatits estimates and assumptions are reasonable, based on information presentlyavailable; however, changes in these estimates, judgments and assumptions willoccur as  result of future events, and,accordingly, actual results could differ from amounts estimated.

*Allowance for Doubtful Accounts*–Mesaba and Big Sky grant trade credit to certain approved customers andperform monthly analyses of outstanding trade receivables to assess thelikelihood of collection.  For balanceswhere Mesaba and Big Sky do not expect full payment of amounts owed, anallowance is recorded to adjust the trade receivable to management’s bestestimate of the amount that will ultimately be collected.

As discussed in Note 2,there is a significant amount of uncertainty surrounding the Northwest andMesaba bankruptcy processes, which may include negotiations with Northwestregarding Mesaba’s ASA.  As such, it isreasonably likely that the prepetition amounts Mesaba ultimately collects willbe different, 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*– Estimated lives are used to record depreciation on aircraft property and equipment.  Aircraft utilization, technology and changesin business strategy may affect the economic lives used to record depreciationby Mesaba 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 Note 2,there is a significant amount of uncertainty surrounding Northwest’s fleetplan.  As such, it is reasonably likelythat Mesaba will alter the estimated useful lives on the aircraft that are tobe returned and accelerate depreciation or impairment charges accordingly.  In future periods, Mesaba will appropriatelyrevise its estimates as it becomes aware of new information.

*Excess and Obsolete Inventories*– Estimated recovery percentages are used to record obsolescence reserves forparts inventories.  Aircraft utilization,parts availability 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.

As discussed in Note 2,Northwest intends to reduce Mesaba’s Saab fleet and eliminate the Avro fleet byDecember 31, 2006.  As a result, Mesabamay require additional excess inventory reserves.  In future periods, Mesaba will appropriatelyrevise its estimates as it becomes aware of new information.

*Aircraft Maintenance*– Estimated maintenance costs and anticipated aircraft activity are used todetermine maintenance reserves.  Changesin maintenance contracts, parts and labor costs and aircraft activity mayaffect the maintenance reserves. Management of Mesaba and Big Sky regularly review aircraft activity, expectedaircraft return dates, changes in maintenance contracts and parts and laborcosts for maintenance reserves.

As discussed in Note 2,there is a significant amount of uncertainty surrounding Northwest’s fleetplan.  As a general rule, Mesaba altersmaintenance accruals on aircraft that are to be returned and reversespreviously established reserves once the aircraft are no longer inservice.  Due to Northwest’s and Mesaba’s bankruptcy proceedings, Mesabawill not reverse maintenance accruals or write off reserves until such time aseither Northwest’s or Mesaba’s bankruptcy court has formally approved therejection of aircraft and the aircraft are removed from Mesaba’s operatingcertificate.  Therefore, in future periods, Mesaba will appropriatelyrevise its maintenance estimates as it becomes aware of new information.

31

----

 

*Intangible Assets*– The excess of the Big Sky purchase price over the fair market value of thenet assets acquired was allocated to certain identifiable intangible assets,including Big Sky’s pilot labor contract and air carrier certificate.  The recoverability of intangible assets isevaluated annually, at a minimum, or on an interim basis if events orcircumstances indicate a possible inability to realize the carryingamounts.  The evaluation includes futurecash flow projections, strategic modeling and other management assumptions.

*Income Taxes* –The Company’s effective tax rate was (24.4%), 32.9% and 46.8% in fiscal 2006,2005 and 2004 respectively.  In fiscal2006, the Company recorded a valuation allowance against its net deferred taxassets in the amount of $3.6 million. The Company’s effective tax rate is based on expected income, statutorytax rates and tax planning opportunities available in the various jurisdictionsin which the Company operates.  In theevent that there is a significant unusual or one-time item recognized, orexpected to be recognized, in the Company’s operating results, the taxattributable to that item would be separately calculated and recorded at thesame time as the unusual or one-time item. Significant judgment is required in determining the Company’s effectivetax rate and in evaluating its tax positions. The Company establishes reserves when, despite its belief that the taxreturn positions are fully supportable, certain positions are likely to bechallenged and may not succeed.  TheCompany adjusts these reserves in light of changing facts and circumstances,such as the closing of a tax audit.  Theeffective tax rate includes the impact of reserve provisions and changes toreserves that are considered appropriate, as well as related interest.  The effective rate is then applied to theCompany’s quarterly operating results.

Significant managementjudgment is required in determining the provisions for income taxes, deferredtax assets and liabilities and any valuation allowance recorded against netdeferred tax assets.  For financialreporting purposes, a valuation allowance is recorded to offset deferred taxassets that, more likely than not, will not be realized based on the Company’sprojected future taxable income, the timing of expiring net operating lossesand the Company’s tax planning strategies. In the future, subsequent revisions to the estimated net realizablevalue of these deferred tax assets could cause the Company to record avaluation allowance on all or a portion of the deferred tax assets.  This could cause the provision for incometaxes to vary significantly from period to period, although the Company’s cashpayments would remain unaffected until the benefit of the net operating lossesis completely utilized or expires unused.

*Workers’ Compensation Insurance*– Mesaba and Big Sky estimate the ultimate cost of an on-the-job injury at thetime of the injury to determine their workers’ compensation insurancereserves.  Mesaba and Big Sky use theservices of their respective insurance carriers and outside brokers to assistin determining the reserve levels. Injury severity, cost of care and the insurance contract affect theultimate cost and ultimate reserves recorded. Management of Mesaba and Big Sky regularly review workers’ compensationactivity with outside consultants for any changes in the workers’ compensationreserve.

*Health and Dental Insurance*– Mesaba estimates the amount of incurred but not reported health and dentalclaims to determine 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. MAIR and Big Sky purchase health and dental insurance and, therefore, donot make estimates for health and dental claims.

*Property Taxes* –Estimated property tax values and assessments are used to record property taxreserves for the various jurisdictions in which Mesaba and Big Skyoperate.  Aircraft and parts values,aircraft flight activity, ground equipment values and the location of personnelmay affect the ultimate property tax obligation.  Management of Mesaba and Big Sky periodicallyreview the above items for any changes in the property tax reserves.

**NEWACCOUNTING PRONOUNCEMENTS**

In July 2006, the FASBissued FASB Interpretation No. 48, *Accounting for Uncertaintyin Income Taxes*—an interpretation of FASB Statement No. 109 (“FIN 48”),which clarifies the accounting for uncertainty in tax positions. FIN 48requires that the Company recognize in its financial statements, the impact ofa tax position, if that position is more likely than not of being sustained onaudit, based on the technical merits of the position. The

32

----

 

accounting provisions ofFIN 48 will be effective for the Company beginning April 1, 2007. The Companyis in the process of determining what effect, if any, the adoption of FIN 48will have on its financial statements.

## **Item 3.  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

The Company’sprincipal market risks are the availability and price of jet fuel and changesin interest rates.

*AircraftFuel*

TheCompany believes that Mesaba’s arrangements for fuel with Northwest assure anadequate supply of fuel for current and future operations, provided thatNorthwest does not experience a supply shortage.  As a part of the ASA, Northwest bears theeconomic risk of fuel price fluctuations for Mesaba’s Saab and CRJ fuelrequirements, as the fuel price for Mesaba’s Saabs is fixed at 83.5 cents pergallon, and the fuel for Mesaba’s CRJS is fixed at 70 cents per gallon.  The ASA also requires Northwest to provideall 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 June 30, 2006, Big Skyhad no fuel hedges in place for fiscal 2007.

*Interest Rates*

TheCompany’s earnings are affected by changes in interest rates due to the impactthose changes have on its interest income from cash equivalents and short- andlong-term investments.  If interest rates were to increase by 100 basispoints for a full year, based on the Company’s cash equivalents, short-term andlong-term investments balance at June 30, 2006, the Company’s interest incomefrom cash equivalents, short-term and long-term investments would increase byapproximately $1.1 million.

TheCompany does not purchase or hold any derivative financial instruments fortrading or speculative purposes.

**ITEM4.  CONTROLS AND PROCEDURES**

*Evaluationof Disclosure Controls Procedures*

The Company’s managementdoes not expect that its disclosure controls and procedures will prevent allerrors and all fraud. A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. Because of the inherent limitationsin all control systems, no evaluation of controls can provide absoluteassurance that all control issues and instances of fraud, if any, within theCompany have been detected. The design of any system of controls also is basedin part upon certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions; over time, control may becomeinadequate because of changes in conditions, or the degree of compliance withthe policies or procedures may deteriorate. Because of the inherent limitationsin a cost-effective control system, misstatements due to error or fraud mayoccur and not be detected.

As of June 30, 2006, theCompany conducted an evaluation under the supervision and with theparticipation of the Company’s management, including the Company’s ChiefExecutive Officer and Chief Financial Officer, regarding the effectiveness ofthe design and operation of the Company’s disclosure controls and procedures(as that term is defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended).  Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective as of thedate of such evaluation.

*Changesin Internal Controls*

During the quarter endedJune 30, 2006, there were no changes in internal controls over financialreporting that had a material effect on internal control over financialreporting or were reasonably likely to have a material effect on internalcontrol over financial reporting.

33

----

 

# **PART II.OTHER INFORMATION**

## **ITEM 1.  LEGALPROCEEDINGS**

*MesabaBankruptcy*

On October 13, 2005,Mesaba filed a voluntary petition for relief under Chapter 11 of the UnitedStates Bankruptcy Code with the United States Bankruptcy Court for the Districtof Minnesota.  The Bankruptcy Court is administeringMesaba’s case under the caption “In re Mesaba Aviation, Inc., dba MesabaAirlines, Case No. 05/39258(GFK).” Mesaba continues to operate its business and manage its property as adebtor-in-possession pursuant to the Bankruptcy Code.  As a result of the Chapter 11 filing,attempts to collect, secure or enforce remedies with respect to prepetitionclaims against Mesaba are subject to the automatic stay provisions of Section362(a) of the Bankruptcy Code, including the Mesaba litigation described below.

*SaabLeasing Litigation*

On October 4, 2002,Fairbrook Leasing, Inc., Lambert Leasing, Inc. and Swedish Aircraft Holdings AB(“Saab Leasing”) filed a declaratory judgment action against Mesaba relating to20 Saab 340A (“340A”) aircraft leased by Mesaba.  Saab Leasing sought a judicial declarationthat the terms of the leases applicable to each of the 340A aircraft aregoverned by a March 7, 1996 term sheet proposal rather than the parties’subsequent agreements and conduct.  In aDecember 8, 2003 order, the District Court declared the term sheet proposal abinding preliminary agreement requiring Mesaba to negotiate in good faithtoward the execution of long-term agreements for each of the 340Aaircraft.  Mesaba appealed the DistrictCourt’s ruling.

On August 13, 2004,relying on the District Court’s declaratory judgment ruling, Saab Leasing fileda separate action in the District Court alleging approximately $35 million indamages for past due and future aircraft lease obligations.  Mesaba denied the allegations in Saab Leasing’scomplaint and contended that it had fulfilled and would continue to fulfill itsexisting obligations.

On May 19, 2005, theUnited States Court of Appeals for the Eighth Circuit affirmed the DistrictCourt’s declaratory judgment ruling. Despite the Eighth Circuit’s ruling, Mesaba believed, based on advicefrom its legal counsel, that it had defenses in the damages case that limitedSaab Leasing’s ability to recover damages. On September 9, 2005, the District Court heard oral arguments on SaabLeasing’s and Mesaba’s cross-motions for summary judgment.  The District Court did not rule on thesemotions prior to Mesaba’s bankruptcy petition.

On October 14, 2005,Mesaba notified the District Court that Mesaba applied for debtor protectionunder Chapter 11 of the Bankruptcy Code and that such application operates toautomatically stay the continuation of the Saab Leasing matter.  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.  OnJuly 6, 2006, the District Court granted Mesaba’s motion for partial summaryjudgment, ruling that Saab Leasing is not eligible to receive damages fromMesaba for the majority of its claims. Because the potential damages for the remaining claim against Mesaba arenot significant, Mesaba has not established any accrual with regard to thislitigation within its condensed financial statements (see Note 13).

*OtherLitigation Matters*

Mesaba is also adefendant in various lawsuits arising in the ordinary course of business. Whilethe outcome of these lawsuits and proceedings cannot be predicted withcertainty, it is the opinion of Mesaba’s management based on currentinformation and legal advice that the ultimate disposition of these suits willnot have a material adverse effect on the separate financial statements ofMesaba or the consolidated financial statements of the Company as a whole.  Additionally, any lawsuit filed against Mesabaprior to the Petition Date is subject to the automatic stay.  If and when these cases proceed, the amountof any damages award to the plaintiffs would be deemed unsecured prepetitionclaims against Mesaba.

34

----

 

## **ITEM 1A.  RISK FACTORS**

The Company’s operationsand financial results are subject to various risks and uncertainties, some ofwhich are described below.  The Companycould also be adversely affected by additional risks and uncertainties notpresently known or believed to be material.

**RisksRelated to Mesaba’s Bankruptcy**

*Mesaba’ssuccessful operation during bankruptcy and its successful emergence frombankruptcy will depend on Mesaba’s relationship with its Creditors’ Committee.*

The United States Trusteefor the District of Minnesota has appointed a Creditors’ Committee in Mesaba’sbankruptcy case.  The Creditors’Committee and its legal representatives have a right to be heard on all mattersthat come before the 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.

*If Mesabais unable to obtain debtor-in-possession financing, it may be unable to emergefrom bankruptcy.*

Mesaba has received acommitment from Marathon to provide $24 million of debtor-in-possessionfinancing.  On August 15, 2006, theBankruptcy Court will consider approval of the debtor-in-possession financingto Mesaba.  However, even if approved bythe Bankruptcy Court, the disbursement of the funds to Mesaba is contingentupon certain occurrences, including Mesaba reaching a resolution with its laborunions, whether by imposing new contract terms on the unions or by reachingconsensual agreements.  If Mesaba isunable to meet all of the lender’s contingencies, Mesaba will not be able todraw on the financing.  In such event,Mesaba could run out of cash and be forced to convert to a Chapter 7 bankruptcyliquidation.

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

The terms of thedebtor-in-possession financing offered to Mesaba by Marathon require suchfinancing to be repaid upon Mesaba’s exit from bankruptcy.  Accordingly, Mesaba will need to provide forthe repayment of its debtor-in-possession financing through a source of exitfinancing or through some other means. There is no assurance that such exit financing will be available toMesaba upon its exit from bankruptcy or that Mesaba will have the means torepay any debtor-in-possession financing without exit financing.

*If Mesabais unable to adopt a successful reorganization plan, it may be unable to emergefrom bankruptcy.*

In order for Mesaba toemerge from bankruptcy, the Bankruptcy Court must approve a reorganization planfor Mesaba.  The reorganization plan willbe subject to a vote by certain classes of creditors, including Mesaba’ssecured creditors and unsecured creditors. The Bankruptcy Court will generally not approve a reorganization planunless all impaired classes of creditors vote to accept the plan; however,Mesaba may elect to invoke certain provisions of the Bankruptcy Code in orderto obtain confirmation 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.

*If MAIRis unable to find an alternate sublessee for Mesaba’s Cincinnati/NorthernKentucky Airport facility, MAIR may incur an additional $8.2 million of expenserelated to the bonds associated with the initial financing of the facility.*

Mesaba currently leases afacility at the Cincinnati/Northern Kentucky International Airport, but vacatedthe facility and ceased making the required lease payments on it in November2005.  MAIR unconditionally guaranteedfull and prompt payment of the ground lease and the bonds associated with theinitial financing of the facility.  Inaccordance with this guaranty, MAIR has made the required bond and ground leasepayments due since November 2005.  In

35

----

 

April 2006, in exchangefor the bondholders forbearing acceleration of the bonds, MAIR delivered a$13.1 million letter of credit to the bondholders to assure payment of thebonds.  As of June 30, 2006, MAIRrecorded a $4.5 million liability with respect to the lease and guaranty, whichassumed that the facility would remain vacant for the next two years, duringwhich time MAIR would continue to make the bond and lease payments, and thatthereafter MAIR would be able to sublease the facility at a 20% discount.  If MAIR is unable to find an alternatesublessee for the facility, MAIR may be required to record an additionalexpense of up to $8.2 million.

*Anycourt-approved reorganization by Mesaba could result in MAIR losing all or aportion of its equity in Mesaba*.

In general, the absolutepriority 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.  It willlikely be some time before Mesaba proposes a reorganization plan.  However, the outcome of any vote on Mesaba’sreorganization plan, as well as the terms and conditions of the plan itself,will determine whether MAIR risks losing some or all of its ownership in Mesabadue to the application of the absolute priority rule.

*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 engaged in negotiations with all of its unions to address theneed for contracts that are consistent with changing company and industryconditions.  To that end, Mesaba filed amotion with the Bankruptcy Court requesting authorization to reject its laborcontracts.  On January 31, 2006, theBankruptcy Court approved the tentative agreement reached between Mesaba andits dispatchers.  The Bankruptcy Courtheard testimony from Mesaba and the remaining three unions in February andMarch 2006.  On May 18, 2006, theBankruptcy Court denied Mesaba’s motion to reject.  Although the Bankruptcy Court agreed withMesaba’s core business assumptions, the court ruled that Mesaba failed tosatisfy certain technical elements required to authorize rejection of the laborcontracts.  On June 12, 2006, Mesabafiled a renewed motion for authority to reject its collective bargainingagreements.  On July 14, 2006, theBankruptcy Court granted Mesaba’s motion, but required that Mesaba provide tendays’ notice before it imposes new contract terms on its unions.

Mesaba has not yetprovided notice of its intention to impose new contract terms, and Mesabaremains committed to reaching negotiated agreements with these unions.  However, there is no guarantee that Mesabawill be able to do so. If tentative agreements are not reached, Mesaba will considerthe appropriate course of action, which could include the imposition of newcontract terms pursuant to the Section 1113(c) process.  If Mesaba does impose new contract termsunder Section 1113(c), the impacted unions may seek to strike or engage inself-help.  Any labor unrest would resultin a material adverse effect on Mesaba’s financial condition and results ofoperations.

*If, inthe process of its investigation, Mesaba’s Creditors’ Committee believes anyimpropriety exists regarding Mesaba’s relationship with MAIR, the Creditors’Committee could assert claims against MAIR.*

Certain provisions of theBankruptcy Code allow a debtor-in-possession to recover transfers of cash orother property that 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 MAIR and Mesaba, including the payment of dividends fromMesaba to MAIR, and to take depositions in order to understand thesetransactions.  MAIR 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 MAIR and Mesaba, MAIR has entered into an agreedprotective order with the Creditors’ Committee to voluntarily provide documentsexplaining the relationship between MAIR and Mesaba and to provide witnesstestimony concerning the documents provided. The Creditors’ Committee has not completed its review of thetransactions between MAIR and Mesaba and, consequently, the Creditors’Committee has not yet advised MAIR of any specific claims arising from itsreview.

36

----

 

*Mesaba has experienced a high attrition rate in itsaccounting, finance and information technology departments, and if Mesaba isunable to replace individuals in these areas, Mesaba’s internal control overfinancial reporting may be adversely affected.*

SinceMesaba filed for bankruptcy protection on October 13, 2005, Mesaba hasexperienced resignations of key personnel in the accounting and SEC reportingfunctions as well as the information technology area, which provides technicalsupport to the finance department.  Additionally, Mesaba has begun toimplement company-wide staff reductions and a reorganization of its operations. Mesaba has added contract workers and consultants as temporary replacements ofthe key personnel who have resigned, and Mesaba expects that it will be able tocontinue to engage consultants and other temporary replacements for thesepositions 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.

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

*Mesaba isdependent 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 for 94.5% of Mesaba’s operating revenues.  Additionally, Mesaba consistently carries areceivable due from Northwest between $12 million to $16 million that is notcollateralized.  Due to Northwest’smissed payments prior to and following its bankruptcy filing, Mesaba recordedan impairment charge to reflect the receivable due from Northwest, net ofcertain offsetting liabilities, through September 13, 2005, the date ofNorthwest’s bankruptcy filing.  Mesaba’sfuture success will depend upon Northwest’s ability to successfully restructurethrough bankruptcy.  Further, Northwest’sbankruptcy has effectively placed Mesaba’s contracts with Northwest at risk, asNorthwest has the option to assume or reject or renegotiate each of suchcontracts in connection with its bankruptcy proceedings.

Mesaba is currentlycontinuing to operate flights for Northwest, but the exact nature of Mesaba’sfuture relationship with Northwest may not be known until such time asNorthwest adopts its bankruptcy reorganization plan.  As of June 30, 2006, Northwest had removed 19Avros and 13 Saabs from Mesaba’s fleet. In January 2006, Northwest advised Mesaba that the remaining Avrosoperated by Mesaba will be removed by the end of December 2006.  On July 1, 2006, Northwest removed one ofMesaba’s CRJs from Mesaba’s schedule and placed 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.    As of July 31, 2006,Mesaba was operating 13 Avros, 50 Saabs and one CRJ pursuant to the ASA.  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 would remainan unsecured claim, and Mesaba would likely receive only a small percentage ofthe amounts owed to it, and even then would only receive such amounts after aplan of reorganization is approved by Northwest’s bankruptcy court.

*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 prohibitNorthwest from contracting with other regional airlines to provide the same servicesthat Mesaba currently provides. Northwest currently has an airline services agreement with Pinnacle, andPinnacle serves many of the same cities as Mesaba.  Northwest has issued a request for proposalfor the operation of up to 126 CRJs (the total number of CRJs that wereoperated by Mesaba and Pinnacle combined), and Northwest has also formed a newsubsidiary, Compass, that could ultimately operate regional aircraft.  Accordingly, Northwest could choose to expandits agreement with Pinnacle in competition with Mesaba, contract with otherregional airlines or replace one or both of its current regional airlinepartners with Compass.

37

----

 

**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 aredependent on various aircraft manufacturers and other vendors to providesufficient parts and related maintenance and support services on a timelybasis.  Additionally, Mesaba and Big Skyrely on various engine manufacturers for parts, repair and overhaul servicesand other types of support services. Mesaba’s bankruptcy and nonpayment for prepetition goods and serviceshas adversely affected its relationship with certain vendors.  The failure of aircraft or enginemanufacturers and other vendors to provide parts or related services on atimely, cost-effective basis could materially and adversely affect Mesaba’s orBig 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 ofaircraft age, the cost of 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.

*If Mesabaloses certain of its ground handling business, Mesaba’s results of operationswould be materially affected.*

Mesaba performs variousground handling services for Northwest, Pinnacle and other airlines atMinneapolis, Detroit and certain other airport locations.  The ground handling business is highlycompetitive, and airlines are constantly reviewing their cost structures tolocate the most cost-effective ground handling providers.  Mesaba does not have any long-term agreementswith Northwest or Pinnacle. If Northwest or Pinnacle terminate Mesaba’s groundhandling services, Mesaba’s financial results would be materially affected,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’sbusinesses are labor-intensive and require large numbers of pilots, flightattendants, maintenance technicians and other personnel.  The airline industry has from time to timeexperienced a shortage of qualified personnel, specifically pilots andmaintenance technicians.  In addition, asis common with most airline competitors, Mesaba and Big Sky have faced turnoverof their employees.  For example, Mesaba’sand Big Sky’s pilots and maintenance technicians, as well as Mesaba’s flightattendants, occasionally leave to work for larger airlines which generallyoffer higher salaries and more extensive benefit programs than regionalairlines are financially able to offer. In the event of a significant increase in the turnover of employees,Mesaba and 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 ishighly competitive, and Northwest competes not only with other regionalcarriers, but also with low-cost airlines and major airlines on many of itsroutes, including the routes that Mesaba flies. Some of these competitors are significantly larger and possess greaterresources than Northwest.  Moreover, anynew entry in the markets Mesaba serves could lessen the economic benefitsNorthwest derives from servicing these markets. Finally, Big Sky also competes with low-cost and regional carriers onits routes, and it faces the same competitive challenges described above.

 

38

----

 

*MAIR’sability to diversify within the airline industry may be limited by the terms ofits side letter agreement with Mesaba’s pilots’ union.*

In January 2004, MAIRentered into a letter agreement with Mesaba’s pilot union that may limit thetypes of aircraft Big Sky may fly and may place additional requirements on MAIRif it 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, MAIR is currentlyassessing its alternatives with respect to the letter agreement.

*Mesaba’sand Big Sky’s compliance with various regulations governing the airline industrycan be costly, and Mesaba and Big Sky could be harmed if they fail to complywith such regulations.*

Airlines are subject toextensive regulatory and legal requirements that involve significant compliancecosts that can result in increased costs for passengers and the airline.  The FAA, DOT and Transportation SecurityAdministration periodically propose additional laws, regulations, taxes andairport fees 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:

·                  warning letters;

·                  fines;

·                  injunctions;

·                  orders relating to grounding ofaircraft, inspection of aircraft, installation of new safety-related items andremoval 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 ofSeptember 11, 2001 and the prolonged unrest in the Middle East materiallyaffected and continue to affect the airline industry.  Concerns about further terrorist attacks havehad a negative impact on air travel demand. In addition, security procedures introduced at airports since theattacks have increased the inconvenience of air travel, both in reality and incustomer perception, leading to further reduction in demand.  Finally, the continued rise in jet fuelprices has had an adverse economic effect on all airlines, including Northwestand Big Sky.  Additional terroristattacks, the fear of such attacks, continued conflict in Iraq, Afghanistan orother countries or continued increases in fuel prices could further affect theairline industry and could cause general instability in financial markets.

Because a substantialportion of air travel, including business travel, is discretionary, theindustry tends to experience adverse financial results during general economicdownturns.  Soft economic conditionscontinue to put pressure on the profitability of the industry.  Any general decline in passenger traffic mayharm the Company’s business.

Mesaba’s and Big Sky’soperations are also subject to delays caused by factors beyond their control,including air traffic congestion at airports, adverse weather conditions andincreased security measures.  Such delaysfrustrate passengers, reduce aircraft utilization and increase costs, all ofwhich may affect profitability and harm the Company’s financial condition andresults of operations.

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

Mesaba and Big Sky havemade substantial investments in technology to manage their operation.  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

39

----

 

hackers.  In addition, large-scale interruption intechnology on which Mesaba and Big Sky depend, such as power,telecommunications or the Internet, could substantially disrupt their operations.

*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 involvingMesaba or Big Sky aircraft could result in injuries and loss of life and,therefore, result in significant claims from injured persons and survivingrelatives.  An accident could also resultin substantial property damage, loss of aircraft from service and adversepublicity for the affected airline.  TheDOT requires airlines to carry liability insurance.  Although Mesaba and Big Sky believe theirliability insurance is in amounts and of the type generally consistent withindustry practice, substantial claims resulting from an accident in excess ofinsurance coverage would harm the Company’s business and financialresults.  Any resulting claims would alsobe costly to defend and could harm Mesaba’s or Big Sky’s reputation.  Moreover, any aircraft accident, even iffully insured or not directly involving Mesaba or Big Sky, could cause a publicperception that flying is less safe or reliable than other transportationalternatives, which could harm the Company’s financial condition and results ofoperations.

**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% ofthe Company’s common stock.  Northwest alsoowns a warrant to purchase an aggregate of 4,112,500 shares of the Company’scommon stock, subject to certain vesting restrictions related to the futuredelivery by Northwest of CRJ aircraft. It is possible that if Mesaba is awarded additional CRJ aircraft byNorthwest, Mesaba and Northwest may negotiate a new airline services agreement,and the Company and Northwest may then also renegotiate the terms of anywarrant that may be issued. Additionally, several other shareholders also own significant blocks ofthe Company’s common stock.  Because theparties described above currently own a large portion of the Company’s stock,they may be able to determine or significantly influence the outcome ofcorporate actions requiring shareholder approval.  As a result, these parties may be in aposition to control matters affecting the Company, including decisions as tothe Company’s direction and policies; future issuances of securities,incurrence of debt, amendments to the Company’s articles of incorporation and bylaws,payment of dividends on the Company’s common stock; and acquisitions, sales ofthe Company’s assets, mergers or similar transactions, including transactionsinvolving a change of control.  As aresult, some investors may be unwilling to purchase the Company’s commonstock.  In addition, if the demand forthe Company’s common stock is reduced because of these shareholders’ control ofthe Company, the price of the Company’s common stock could be materiallydepressed.

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

Sales of a large numberof shares of the Company’s common stock or the availability of a large numberof shares for sale could adversely affect the market price of the Company’s commonstock.  As of June 30, 2006, the Companyhad 20,591,840 shares of common stock outstanding.  Several of the Company’s shareholders ownsubstantial blocks of the Company’s common stock.  Additionally, along with the shares of stockit currently owns, Northwest could own an additional large block of the Company’scommon stock upon exercise of its warrant. In connection with the ASA, the Company entered into a registrationrights agreement to register the shares of stock owned by Northwest (includingthose shares underlying its warrant). Prior to entering the ASA, Northwest had pledged certain of these sharesto Boeing Capital Corporation, and Boeing is also a party to the registrationrights agreement.  The registrationstatement has not been filed, and will likely not be filed until either a finalresolution is reached with respect to the ASA (unless Boeing obtains relieffrom the automatic stay and is allowed to foreclose on Northwest’s stock pledgeand subsequently demand registration). Nevertheless, following any registration, future sales of those shares,or future sales of other large blocks of the Company’s common stock that arealready registered, could substantially depress the Company’s stock price.

40

----

 

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

As of June 30, 2006,Northwest held a warrant exercisable for an aggregate of 4,112,500 shares ofthe Company’s common stock at an exercise price of $8.74 per share.  To date, this 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 fiscalyears, the market price of the Company’s common stock has ranged from a low of$4.50 per share to a high of $10.23 per share. Because the Company’s stock is thinly traded, its market price issensitive and may continue to experience substantial fluctuations due to avariety of factors, including the following:

·                  failure of the Company’s operatingresults to meet analysts’ or investors’ expectations in any quarter;

·                  securities analysts’ estimates;

·                  material announcements by theCompany, Northwest or the Company’s, Mesaba’s or Big Sky’s competitors;

·                  public sales of a substantial numberof shares of the Company’s common stock;

·                  increased short sales due to theuncertainty surrounding Mesaba’s bankruptcy, as well as any purchase to covershort positions;

·                  regulatory actions; or

·                  generalmarket conditions.

*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 ofincorporation and bylaws, along with Minnesota law, could discourage, delay orprevent persons from 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.  TheCompany’s bylaws grant the board of directors the authority to adopt, amend orrepeal all or any of such bylaws, subject to the power of the shareholders tochange or repeal such bylaws.  TheCompany’s bylaws also limit who may call meetings of the Company’sshareholders.

As a public corporation,the Company is prohibited by the Minnesota Business Corporation Act, exceptunder certain specified circumstances, from engaging in any merger, significantsale of stock or assets or business combination with any shareholder or groupof shareholders who own at least 10% of the Company’s common stock.

41

----

 

**ITEM6.  EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Document  Description**                                                                                         |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                              |
| 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.                         |

 

42

----

 

**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|                  | MAIR Holdings, Inc.                                                                                                               |                     |
|-----------------------|-----------------------------------------------------------------------------------------------------------------------------------|--------------------------|
|                  |                                                                                                                              |                     |
|                  |                                                                                                                              |                     |
| Dated: August 8, 2006 | By:                                                                                                                               |  /s/ Robert E. Weil |   |
|                  | Robert E. Weil

Vice President, Chief Financial Officer and  Treasurer  (principal financial officer and an authorized signatory) |
|                       |                                                                                                                                   |                          |  |  |

 

43

----