**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**ý****QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934.**

 

**For thequarterly period ended June 30, 2005**

 

**OR**

 

**o****TRANSITION REPORT PURSUANT TO SECTION 13OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition periodfrom           to          **

 

**CommissionFile No:  0-17895**

 

**MAIR HOLDINGS, INC.**

Incorporated under the laws ofMinnesota

 

| **41-1616499**                            |
|-------------------------------------------|
| (I.R.S.  Employer ID No.)                 |
|                                      |
| **Fifth  Street Towers, Suite 1360** |
| **150  South Fifth Street**               |
| **Minneapolis,  MN 55402**                |
| **(612) 333-0021**                        |

 

Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15 (d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

 

Yes ý    Noo

 

Indicate by check mark whether the registrant is an accelerated filer(as defined in Rule 12b-2 of the Act).

 

Yes ý    Noo

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 
| **Class**                             | ** ** | **Outstanding as of July 30, 2005** |
|---------------------------------------|------------|------------------------------------------|
| Common Stock Par value $.01 per share |       | 20,574,340                               |

 

 

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**CAUTIONARYNOTE REGARDING FORWARD-LOOKING STATEMENTS**

 

Statements in this Quarterly Report on Form 10-Q of MAIR Holdings, Inc.(the “Company”) under the caption “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and elsewhere in this report areforward-looking and are based upon information currently available to theCompany.  The Company, through itsofficers, directors or 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 described underthe caption “Certain Risk Factors Relating to the Company and the AirlineIndustry” in Item 2 of this Quarterly Report on Form 10-Q and in theCompany’s Annual Report on Form 10-K for the fiscal year ended March 31,2005.

 

Undue reliance should not be placed on the Company’s forward-lookingstatements because the matters they describe are subject to known and unknownrisks, uncertainties and other unpredictable factors, many of which are beyondthe Company’s control.  The Company’sforward-looking statements speak only as of the date on which they are made.  Over time, actual results, performance orachievements will likely differ from the anticipated results, performance orachievements that are expressed or implied by the Company’s forward-lookingstatements, and such differences might be significant and materially adverse tothe Company’s shareholders.

 

All 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 Companyassumes no obligation, and disclaims any obligation, to update information containedin this Quarterly Report on Form 10-Q, including forward-lookingstatements, as a result of facts, events or circumstances after the date ofthis report, except as required by law in the normal course of its publicdisclosure practices.

 

2

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**Part I.  FINANCIAL INFORMATION**

 

**ITEM 1.  CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**MAIRHOLDINGS, INC.**

**CONDENSED CONSOLIDATEDBALANCE SHEETS**

**(inthousands, except share information)**

**(Unaudited)**

 
| ** **                                             | ** ** | **June 30** | ** ** | **March 31** | ** ** |
|--------------------------------------------------------|------------|------------------|------------|-------------------|------------|
| ** **                                             | ** ** | **2005**         | ** ** | **2005**          | ** ** |
| ASSETS                                                 |       |             |       |              |       |
|                                                   |       |             |       |              |       |
| CURRENT  ASSETS:                                       |       |             |       |              |       |
| Cash and  cash equivalents                             |       | $                | 66,516     |              | $          | 57,968 |   |
| Short-term  investments                                |       | 63,936           |       | 69,669            |       |
| Accounts  receivable, net of reserves of $570 and $601 |       | 27,678           |       | 31,176            |       |
| Inventories,  net                                      |       | 11,955           |       | 11,034            |       |
| Prepaid  expenses and deposits                         |       | 5,586            |       | 5,808             |       |
| Deferred  income taxes and other                       |       | 11,627           |       | 11,892            |       |
| Total  current assets                                  |       | 187,298          |       | 187,547           |       |
|                                                   |       |             |       |              |       |
| PROPERTY AND  EQUIPMENT:                               |       |             |       |              |       |
| Flight  equipment                                      |       | 94,871           |       | 93,645            |       |
| Other  property and equipment                          |       | 41,749           |       | 40,248            |       |
| Less:  Accumulated depreciation and amortization       |       | (98,549          | )          | (95,472           | )          |
| Net property  and equipment                            |       | 38,071           |       | 38,421            |       |
|                                                   |       |             |       |              |       |
| NONCURRENT  ASSETS:                                    |       |             |       |              |       |
| Long-term  investments                                 |       | 42,118           |       | 43,240            |       |
| Goodwill                                               |       | 2,503            |       | 2,503             |       |
| Other  intangible assets, net                          |       | 2,717            |       | 2,819             |       |
| Other  assets, net                                     |       | 6,027            |       | 6,424             |       |
|                                                   |       | $                | 278,734    |              | $          | 280,954 |   |

 

The accompanying notes are an integral part of these unauditedcondensed consolidated financial statements.

 

3

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**MAIRHOLDINGS, INC.**

**CONDENSED CONSOLIDATEDBALANCE SHEETS (Continued)**

**(inthousands, except share information)**

**(Unaudited)**

 
| ** **                                                                                                            | ** ** | **June 30** | ** ** | **March 31** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-------------------|------------|
| ** **                                                                                                            | ** ** | **2005**         | ** ** | **2005**          | ** ** |
|                                                                                                                  |       |             |       |              |       |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                                            |       |             |       |              |       |
|                                                                                                                  |       |             |       |              |       |
| CURRENT  LIABILITIES:                                                                                                 |       |             |       |              |       |
| Accounts  payable                                                                                                     |       | $                | 16,128     |              | $          | 19,151 |   |
| Accrued  liabilities:                                                                                                 |       |             |       |              |       |
| Payroll                                                                                                               |       | 18,230           |       | 19,563            |       |
| Maintenance                                                                                                           |       | 20,201           |       | 20,281            |       |
| Deferred  income                                                                                                      |       | 3,401            |       | 3,085             |       |
| Other  current liabilities                                                                                            |       | 21,302           |       | 20,126            |       |
| Total  current liabilities                                                                                            |       | 79,262           |       | 82,206            |       |
|                                                                                                                  |       |             |       |              |       |
| OTHER  NONCURRENT LIABILITIES                                                                                         |       | 5,480            |       | 6,069             |       |
|                                                                                                                  |       |             |       |              |       |
| 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, 20,574,340 shares issued  and outstanding                |       | 206              |       | 206               |       |
| Paid-in  capital                                                                                                      |       | 54,378           |       | 54,356            |       |
| Warrants                                                                                                              |       | 16,500           |       | 16,500            |       |
| Accumulated  other comprehensive loss                                                                                 |       | (165             | )          | (254              | )          |
| Retained  earnings                                                                                                    |       | 123,073          |       | 121,871           |       |
| Total  shareholders’ equity                                                                                      |       | 193,992          |       | 192,679           |       |
|                                                                                                                  |       | $                | 278,734    |              | $          | 280,954 |   |

 

The accompanying notes are an integral part of these unaudited condensedconsolidated financial statements.

 

4

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**MAIRHOLDINGS, INC.**

**CONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS**

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

**(Unaudited)**

 
| ** **                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **June 30**       | ** ** |
| ** **                                | ** ** | **2005**               | ** ** | **2004** | ** ** |
| ** **                                | ** ** | ** **             | ** ** | **(As restated-  see Note 13)** | ** ** |
| OPERATING  REVENUES:                      |       |                   |       |   |   |
| Passenger                                 |       | $                      | 107,539    |   | $ | 100,968 |   |
| Freight and  other                        |       | 10,900                 |       | 8,731 |   |
| Total  operating revenues                 |       | 118,439                |       | 109,699 |   |
|                                      |       |                   |       |   |   |
| OPERATING  EXPENSES:                      |       |                   |       |   |   |
| Wages and  benefits                       |       | 39,388                 |       | 35,300 |   |
| Aircraft  fuel                            |       | 5,658                  |       | 5,111 |   |
| Aircraft  maintenance                     |       | 22,771                 |       | 20,426 |   |
| Aircraft  rents                           |       | 25,665                 |       | 25,106 |   |
| Landing fees                              |       | 1,676                  |       | 1,769 |   |
| Insurance  and taxes                      |       | 1,893                  |       | 2,073 |   |
| Depreciation  and amortization            |       | 3,802                  |       | 3,753 |   |
| Administrative  and other                 |       | 18,504                 |       | 13,637 |   |
| Total  operating expenses                 |       | 119,357                |       | 107,175 |   |
| Operating  income (loss)                  |       | (918                   | )          | 2,524 |   |
|                                      |       |                   |       |   |   |
| NONOPERATING  INCOME (EXPENSE):           |       |                   |       |   |   |
| Interest  income and other                |       | 1,012                  |       | 385 |   |
| Interest  expense                         |       | (16                    | )          | (18 | ) |
| Arbitration  settlement                   |       | 1,800                  |       | — |   |
| Nonoperating  income, net                 |       | 2,796                  |       | 367 |   |
| Income  before provision for income taxes |       | 1,878                  |       | 2,891 |   |
|                                      |       |                   |       |   |   |
| PROVISION  FOR INCOME TAXES               |       | 676                    |       | 28 |   |
| NET INCOME                                |       | $                      | 1,202      |   | $ | 2,863 |   |
|                                      |       |                   |       |   |   |
| NET INCOME  PER SHARE:                    |       |                   |       |   |   |
| Earnings per  common share - basic        |       | $                      | 0.06       |   | $ | 0.14 |   |
| Earnings per  common share - diluted      |       | $                      | 0.06       |   | $ | 0.14 |   |
|                                      |       |                   |       |   |   |
| WEIGHTED  AVERAGE SHARES OUTSTANDING:     |       |                   |       |   |   |
| Basic                                     |       | 20,574                 |       | 20,452 |   |
| Diluted                                   |       | 21,194                 |       | 20,976 |   |

 

The accompanying notes are an integral part of these unaudited condensedconsolidated financial statements.

 

5

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**MAIRHOLDINGS, INC.**

**CONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(inthousands)**

**(Unaudited)**

 
| ** **                                                                         | ** ** | **Three Month Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                         | ** ** | **June 30**      | ** ** |
| ** **                                                                         | ** ** | **2005**              | ** ** | **2004** | ** ** |
| ** **                                                                         | ** ** | ** **            | ** ** | **(As restated-** | ** ** |
| ** **                                                                         | ** ** | ** **            | ** ** | **see Note 13)** | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                             |       |                  |       |   |   |
| Net income                                                                         |       | $                     | 1,202      |   | $ | 2,863 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                  |       |   |   |
| Depreciation  and amortization                                                     |       | 3,802                 |       | 3,753 |   |
| Amortization  of investments                                                       |       | 465                   |       | 521 |   |
| Amortization  of deferred credits                                                  |       | (348                  | )          | (412 | ) |
| Stock-based  compensation                                                          |       | 22                    |       | (740 | ) |
| Changes in  current operating items:                                               |       |                  |       |   |   |
| Accounts  receivable                                                               |       | 3,498                 |       | 408 |   |
| Inventories                                                                        |       | (921                  | )          | (723 | ) |
| Prepaid  expenses and deposits                                                     |       | 240                   |       | (1,853 | ) |
| Accounts  payable and other                                                        |       | (2,979                | )          | (6,699 | ) |
| Net cash  provided by (used in) operating activities                               |       | 4,981                 |       | (2,882 | ) |
|                                                                               |       |                  |       |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                             |       |                  |       |   |   |
| Purchases of  investments                                                          |       | (11,441               | )          | (11,200 | ) |
| Sales of  investments                                                              |       | 18,002                |       | 12,383 |   |
| Purchases of  property and equipment                                               |       | (2,964                | )          | (2,971 | ) |
| Net cash  (used in) provided by investing activities                               |       | 3,597                 |       | (1,788 | ) |
|                                                                               |       |                  |       |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES                                              |       |                  |       |   |   |
| Repayment of  other noncurrent liabilities                                         |       | (30                   | )          | (33 | ) |
| Proceeds  from issuance of common stock                                            |       | —                |       | 530 |   |
| Net cash  provided by (used in) financing activities                               |       | (30                   | )          | 497 |   |
|                                                                               |       |                  |       |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                              |       | 8,548                 |       | (4,173 | ) |
|                                                                               |       |                  |       |   |   |
| CASH AND  CASH EQUIVALENTS:                                                        |       |                  |       |   |   |
| Beginning of  period                                                               |       | 57,968                |       | 52,661 |   |
| End of  period                                                                     |       | $                     | 66,516     |   | $ | 48,488 |   |
|                                                                               |       |                  |       |   |   |
| SUPPLEMENTARY  CASH FLOW INFORMATION:                                              |       |                  |       |   |   |
| Cash paid  (refund received) during period for:                                    |       |                  |       |   |   |
| Interest                                                                           |       | $                     | 17         |   | $ | 21 |   |
| Income taxes                                                                       |       | $                     | (420       | ) | $ | 463 |   |

 

The accompanying notes are an integral part of these unaudited condensedconsolidated financial statements.

 

6

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**MAIR HOLDINGS, INC.**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

**(Unaudited)**

 

The condensed consolidated financial statements included herein havebeen prepared by MAIR Holdings, Inc. (the “Company” or “Holdings”),without audit, pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”).  Theinformation furnished in the condensed consolidated financial statementsincludes normal recurring adjustments and reflects all adjustments that are, inthe opinion of management, necessary for a fair presentation of such condensed consolidatedfinancial statements.  The Company’sbusiness is seasonal and, accordingly, interim results are not indicative ofresults for a full year.  Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with accounting principles generally accepted in theUnited States of America (“GAAP”) have been condensed or omitted pursuant tosuch rules and regulations, although the Company believes that thedisclosures are adequate to make the information presented not misleading.  These condensed consolidated financialstatements should be read in conjunction with the consolidated financialstatements for the year ended March 31, 2005, and the notes thereto,included in the Company’s Annual Report on Form 10-K as filed with the SECon June 14, 2005.

 

1.               Basis ofPresentation

 

The condensed consolidated financial statements include the accounts ofthe Company and its wholly owned subsidiaries, Mesaba Aviation, Inc. (“Mesaba”)and Big Sky Transportation Co. (“Big Sky”). All significant intercompany transactions and balances have beeneliminated in consolidation.

 

The preparation of the condensed consolidated financial statements inconformity with GAAP requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities, as well as the reported amounts of revenuesand expenses.  The most significant useof estimates relates to accrued maintenance expenses, aircraft property andequipment lives, inventory obsolescence reserves, valuation of goodwill andother intangible assets and accounting for income taxes.  Ultimate results could differ from thoseestimates.

 

2.               Business

 

*Mesaba*

Mesaba operates as a regional air carrier providing scheduled passengerservice as “Mesaba Airlines/Northwest Airlink” and “Mesaba Airlines/NorthwestJet Airlink” under two separate agreements with Northwest Airlines, Inc. (“Northwest”),a wholly owned indirect subsidiary of Northwest Airlines Corporation.  As of June 30, 2005, Mesaba served 110cities in the United States and Canada from Northwest’s hub airports located inMinneapolis/St. Paul, Detroit and Memphis.

 

Under the Airline Services Agreement (the “Airlink Agreement”), Mesabaoperates Saab 340 jet-prop aircraft (“Saab”) for Northwest.  This agreement provides for exclusive rightsto designated service areas and extends through June 30, 2007.  Under the Airlink Agreement, Mesabarecognizes revenue for each completed “available seat mile” (the number ofseats in an aircraft multiplied by the number of miles those seats areflown).  Additionally, under the AirlinkAgreement, Mesaba purchases fuel, ground handling and other services fromNorthwest.  Mesaba, on a net basis, paidNorthwest $3.3 million and $6.2 million for these services for the three monthsended June 30, 2005 and 2004, respectively.  Either Northwest or Mesaba may terminate theAirlink Agreement on 365 days notice. The Airlink Agreement may be terminated immediately by Mesaba orNorthwest in the event that the other party is the subject of a bankruptcy orsimilar proceeding or is divested of a substantial part of its assets.  Additionally, the non-defaulting party mayterminate the agreement in the event of a breach of a non-monetary provisionthat remains uncured for a period of more than 30 days after receipt ofwritten notification of such default, or the breach of a monetary provisionthat remains uncured for a period of more than ten days after receipt ofwritten notification of such default. Northwest may also terminate the Airlink Agreement in the event ofcertain lease and other performance defaults; change in control events;revocation or failure to obtain Department of Transportation (“DOT”)certification; failure to elect a chief executive officer of the Company andMesaba reasonably acceptable to Northwest; or if more than 50% of the aircraftsubject to the agreement are not operated for more than seven consecutive daysor 25% of such aircraft are not operated for more than 21 consecutive days,other than as a result of the Federal Aviation Administration (“FAA”) groundingall Saabs for all carriers.

 

Under the Regional Jet Services Agreement (the “Jet Agreement”), Mesabaoperates Avro RJ85 regional jets (“RJ85”) for Northwest.  The Jet Agreement extends through April 25,2007.  Under the Jet Agreement, Mesabarecognizes revenue for each “block hour” flown (the elapsed time betweenaircraft departing and arriving at a gate). Northwest provides fuel and airport and passenger related services atNorthwest’s expense.  Either Mesaba orNorthwest may immediately terminate the Jet Agreement in the event that theother party is the subject of a bankruptcy or similar proceeding or is divestedof a

 

7

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substantial part of its assets. Additionally, the non-defaulting party may terminate the agreement inthe event of a breach of a non-monetary provision that remains uncured for aperiod of more than 30 days after receipt of written notification of suchdefault, or the breach of a monetary provision that remains uncured for aperiod of more than ten days after receipt of written notification of suchdefault.  Northwest may also terminatethe Jet Agreement in the event of certain lease and other performance defaults;change in control events; revocation or failure to obtain DOT certification;failure to elect a chief executive officer of the Company and Mesaba reasonablyacceptable to Northwest; if more than 25% of the aircraft subject to theagreement are not operated for more than seven consecutive days, other than asa result of the FAA grounding all RJ85 aircraft for all carriers; or if thereis a strike, cessation or interruption of work involving Mesaba pilots, flightattendants or mechanics providing jet service.

 

Under the agreements, all scheduled flights that Mesaba operates aredesignated as Northwest flights using Northwest’s designator code in allcomputer reservation systems, including the Official Airline Guide, 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, rather than at the more remote commuter air terminals.  Mesaba’s RJ85 aircraft are painted in thecolors of Northwest and the Saab aircraft are painted in a distinctive “NorthwestAirlink” configuration, with a Northwest logo in addition to Mesaba’s name.

 

Mesaba, through the agreements, receives ticketing and certaincheck-in, baggage, freight and aircraft handling services from Northwest atcertain airports.  In addition, Mesabareceives its computerized reservations services from Northwest.  Northwest also performs all marketing,scheduling, yield management and pricing services for Mesaba’s flights.

 

The Airlink and Jet Agreements provide for certain incentive paymentsfrom Northwest to Mesaba based on achievement of certain operational orfinancial goals.  Such incentives totaled$1.4 million and $1.2 million for the three months ended June 30, 2005 and2004, respectively, and are included in passenger revenues in the accompanyingcondensed consolidated statements of operations.  Approximately $22.8 million, or 82.4%, and$25.9 million, or 83.0%, of the June 30, 2005 and March 31, 2005accounts receivable balances in the accompanying condensed consolidated balancesheets were due from Northwest and were not collateralized.

 

For the years ended December 31, 2004, 2003 and 2002, Northwest’snet income (loss) was $(862) million, $248 million and $(798) million.  As of March 31, 2005, Northwest had astockholders’ equity deficit of $3.5 billion and negative working capital of$1.2 billion.  If Northwest continues toincur operating losses, it may be unable to fulfill its financial obligations,including payments due to Mesaba under the Airlink Agreement and Jet Agreement.  Additionally, the Company’s business could beadversely affected by events such as a reorganization by Northwest throughChapter 11 bankruptcy proceedings, an inability by Northwest to reduce laborexpenses and other costs, continued and unsustainable operating losses atNorthwest, changes in Northwest’s business plan or model, employee strike orjob actions, significant curtailment of service (and thus curtailment of theutilization of the Company’s aircraft), continued volatility of fuel costs andterrorist events.  Loss of the Company’sbusiness relationship with Northwest or Northwest’s failure to make timelypayment of amounts owed to the Company would have a material adverse effect onthe Company’s operations, financial position and cash flows.

 

Pursuant to a non-binding letter of intent, Mesaba and Northwest arecurrently negotiating a new omnibus airline services agreement intended toreplace the Airlink Agreement and Jet Agreement.  See the “Recent Developments” section below.

 

*Big Sky*

Big Sky operates as a regional air carrier based in Billings, Montana,primarily providing scheduled passenger, airfreight, express package andcharter services.  As of June 30,2005, Big Sky provided scheduled air service to 18 communities in Montana,Idaho, Oregon, Washington, Colorado 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 andNorthwest, where its services are marketed jointly with those air carriers forconnecting flights.  Big Sky participatesin the Essential Air Service (“EAS”) program with the DOT.  The EAS program subsidizes air carriers toprovide air service to designated rural communities throughout the country thatcould not otherwise economically justify that service based on their passengertraffic.  The DOT pays EAS subsidies foreach departure in a covered market.  Inthe three months ended June 30 2005 and 2004, Big Sky recognized revenuefrom EAS subsidies of $2.0 million and $1.6 million.  Big Sky purchased fuel from Northwest for $0.8million and $0.4 million for the three months ended June 30, 2005 and 2004,respectively.

 

8

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*Recent Developments*

On April 22, 2005, Holdings and Mesaba executed a non-bindingletter of intent with Northwest to allow Mesaba to operate 15 Bombardier CRJ-200regional jets (“CRJ”) under the Northwest Airlink banner, with exclusive rightsto the next 20 CRJ-200 or CRJ-440 aircraft Northwest may order.  Mesaba expects to lease the aircraft fromNorthwest and expects the first aircraft to enter service before the end of calendar2005.  Mesaba expects to enter into a new10-year omnibus airline services agreement with Northwest covering theoperation of the CRJs, Saabs and RJ85s that will replace the existing AirlinkAgreement and the Jet Agreement, which are set to expire in 2007.  As part of the letter of intent, Mesabaagreed to incur the costs necessary to bring the new CRJ fleet into service.

 

Holdings and Mesaba are currently negotiating the definitive newomnibus airline services agreement with Northwest, which is subject to finalapproval by all parties.  Upon executionof the definitive agreement, Holdings expects to amend the currentlyoutstanding warrants held by Northwest to reduce the number of shares of theCompany’s common stock issuable upon exercise from 4,151,922 shares exercisableat prices 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 warrants are expected to expire ten years from the date of thedefinitive airline services agreement. Sixty percent of the shares are expected to become exercisable upon thedelivery of the 15th CRJ aircraft to Mesaba, and an additional 4% of the sharesare expected to become exercisable with each subsequent delivery of the nextten CRJ aircraft.  Pursuant to the letterof intent, Holdings also agreed to enter into a registration rights agreementto register the shares of stock currently held by Northwest and the shares ofstock that will be issuable to Northwest upon exercise of the warrants.

 

As of the date of this filing, the Company and Mesaba are continuingnegotiations on the definitive new omnibus airline services agreement.  Because the letter of intent is non-binding,the Company cannot provide assurance that the parties will ultimately execute afinal agreement.  In the first fiscalquarter, Mesaba incurred approximately $2.4 million in start-up costs relatedto adding the CRJ aircraft into its fleet, and Holdings incurred approximately$0.3 million in related start-up costs.  If the parties do not execute a definitiveagreement, Mesaba would be unable to earn revenue from the CRJ fleet to offsetthese and future start-up expenses. Additionally, Northwest is in a 30-day cooling off period with itsmechanics, and the mechanics could strike as soon as August 19, 2005.  Further, in the event Northwest continues toincur losses, it may file for bankruptcy. In such event, all of the Company’s contracts with Northwest will be atrisk, as Northwest will have the option to accept or reject each of the Company’scontracts with Northwest.  Northwestcould also attempt to renegotiate the Company’s contracts through bankruptcy.  For a detailed discussion of the risksassociated with the Company’s airline services agreements with Northwest,please see “Certain Risk Factors Relating to the Company and the AirlineIndustry” in Item 2 of this Quarterly Report on Form 10-Q.

 

3.               Goodwill andOther Intangibles

 

Theexcess of the Big Sky purchase price over the fair market value of the netassets acquired was allocated to certain identifiable intangible assets,including Big Sky’s pilot labor contract and an air carrier certificate, and togoodwill.  Goodwill and other intangibleassets and related accumulated amortization were as follows, in thousands:

 
| ** **                     | ** ** | **June 30, 2005** | ** ** | **March 31, 2005** | ** ** |
|--------------------------------|------------|------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | ** **             | ** ** | **Accumulated**         | ** ** | ** ** | ** ** | ** ** | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **Gross**              | ** ** | **Amortization**        | ** ** | **Net** | ** ** | **Gross** | ** ** | **Amortization** | ** ** | **Net** | ** ** |
| Indefinite-lived  assets:      |       |                   |       |                    |       |   |   |   |   |   |   |   |   |
| Air carrier  certificate       |       | $                      | 925        |                    |       |   | $ | 925 |   | $ | 925 |   |   |   | $ | 925 |   |
| Goodwill                       |       | 2,503                  |       |                    |       | 2,503 |   | 2,503 |   |   |   | 2,503 |   |
| Amortizable  intangible asset: |       |                   |       |                    |       |   |   |   |   |   |   |   |   |
| Pilot labor  contract          |       | 2,840                  |       | (1,048                  | )          | 1,792 |   | 2,840 |   | (946 | ) | 1,894 |   |
|                           |       | $                      | 6,268      |                    | $          | (1,048 | ) | $ | 5,220 |   | $ | 6,268 |   | $ | (946 | ) | $ | 5,322 |   |
|                                |            |                        |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The amortizable intangible asset is amortized over its estimated periodof benefit.  Intangible assetamortization expense for each of the three months ended June 30, 2005 and2004 was $0.1 million.  Goodwill and theintangible assets are evaluated for impairment annually, at a minimum, or on aninterim basis if events or circumstances indicate a possible inability torealize the carrying amounts.  Theevaluation includes future cash flow projections, strategic modeling and othermanagement assumptions.  During thefourth quarter of each fiscal year, the Company completes its annual impairmenttest of goodwill and other intangible assets. The Company continues to monitor goodwill and the intangible assets atBig Sky for impairment.

 

9

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4.               Investments

 

Investments consist principally of municipal securities and areclassified as available-for-sale.  Fairvalue of investments are determined based on quoted market prices.  The Company classifies investments with anoriginal maturity of more than 90 days that mature within one year asshort-term and greater than one year as long-term.

 

As of June 30, 2005 and March 31, 2005, cash, cash equivalents,short-term and long-term investments totaled $172.6 million and $170.9 million.

 

Amortized cost, gross unrealized gains and losses and fair value of shortand long-term investments classified as debt securities available-for-sale wereas follows, in thousands:

 
| ** **               | ** ** | **June 30, 2005** | ** ** | **March 31, 2005** | ** ** |
|--------------------------|------------|------------------------|------------|-------------------------|------------|
| Amortized  cost          |       | $                      | 106,319    |                    | $          | 113,346 |   |
| Gross  unrealized gains  |       | 14                     |       | 3                       |       |
| Gross  unrealized losses |       | (279                   | )          | (440                    | )          |
| Fair value               |       | $                      | 106,054    |                    | $          | 112,909 |   |

 

For the three months ended June 30, 2005 and 2004, gross realizedgains and losses were insignificant as the Company generally holds the fullyamortized bonds to maturity.

 

5.               StockOptions

 

The Company accounts for its stock-based compensation plans using theintrinsic value method prescribed under Accounting Principles Board (“APB”) OpinionNo. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations.  The Company has issuedstock options to key employees and directors. As such, the Company records compensation expense for stock options andawards only if the exercise price is less than the fair market value of thestock on the measurement date.

 

For purposes of the pro forma disclosures of compensation expense underStatement of Financial Accounting Standards (“SFAS”) No. 123, “Accountingfor Stock-Based Compensation” and SFAS No. 148, “Accounting forStock-Based Compensation-Transition and Disclosure,” the Company uses theBlack-Scholes option model to estimate the fair value of options not subject tovariable plan accounting.

 

The following information summarizes the pro forma effects assumingcompensation for such awards had been recorded based upon the estimated fairvalue for the periods ended June 30, in thousands, except per shareinformation:

 

10

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| ** **                                                                                                                              | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                                              | ** ** | **June 30**       | ** ** |
| ** **                                                                                                                              | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Net income  as reported                                                                                                                 |       | $                      | 1,202      |   | $ | 2,863 |   |
| Add:  Stock-based employee compensation expense (reduction) included in reported  net income, net of related tax effects                |       | 14                     |       | (426 | ) |
| Deduct:  Stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | (210                   | )          | (474 | ) |
| Pro forma  net income                                                                                                                   |       | $                      | 1,006      |   | $ | 1,963 |   |
|                                                                                                                                    |       |                   |       |   |   |
| Earnings per  common share – basic:                                                                                                |       |                   |       |   |   |
| As reported                                                                                                                             |       | $                      | 0.06       |   | $ | 0.14 |   |
| Pro forma                                                                                                                               |       | $                      | 0.05       |   | $ | 0.10 |   |
| Earnings per  common share – diluted:                                                                                              |       |                   |       |   |   |
| As reported                                                                                                                             |       | $                      | 0.06       |   | $ | 0.14 |   |
| Pro forma                                                                                                                               |       | $                      | 0.05       |   | $ | 0.09 |   |

 

InDecember 2002, the Company repriced stock options to purchase 745,000shares of the Company’s common stock with exercise prices ranging from $9.05 to$18.00 to an exercise price of $5.97, which represented the fair market valueon the date of the repricing.  As of June 30,2005, 514,782 repriced options were outstanding.  In accordance with Financial Accounting StandardsBoard (“FASB”) Interpretation No. 44, “Accounting for Certain TransactionsInvolving Stock Compensation,” the Company adopted variable plan accounting forthese options from the date of the repricing. The Company recorded no compensation expense for the three months ended June 30,2005 and the Company recorded a reduction in compensation expense of $0.7million for the three months ended June 30, 2004.

 

6.               Earnings PerShare

 

Basic earnings per common share is computed by dividing net income by theweighted average number of shares of common stock outstanding during theperiod.  Diluted earnings per share iscomputed by dividing net income 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.  Stockoptions and warrants with an exercise price exceeding the fair market value ofthe Company’s common stock are considered antidilutive and are excluded fromthe calculation.

 

The following table reconciles the number of shares utilized in the condensedconsolidated earnings per share calculations for the periods endedJune 30, in thousands,except per share information:

 

11

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| ** **                                                                                                   | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                                                   | ** ** | **June 30**       | ** ** |
| ** **                                                                                                   | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Net income                                                                                                   |       | $                      | 1,202      |   | $ | 2,863 |   |
| For earnings  per common share - basic:                                                                      |       |                   |       |   |   |
| Weighted  average number of issued shares outstanding                                                        |       | 20,574                 |       | 20,452 |   |
| Effect of  dilutive securities:                                                                              |       |                   |       |   |   |
| Computed  shares outstanding under the Company’s stock option plan utilizing the  treasury stock method |       | 435                    |       | 387 |   |
| Computed  shares outstanding under warrants issued utilizing the treasury stock method                       |       | 185                    |       | 137 |   |
| For earnings  per common share - diluted:                                                                    |       |                   |       |   |   |
| Weighted  average common shares and potentially dilutive common shares                                       |       | 21,194                 |       | 20,976 |   |
| Earnings per  common share – basic                                                                      |       | $                      | 0.06       |   | $ | 0.14 |   |
| Earnings per  common share – diluted                                                                    |       | $                      | 0.06       |   | $ | 0.14 |   |
|                                                                                                         |       |                   |       |   |   |
| Antidilutive  options and warrants                                                                           |       | 3,355                  |       | 3,505 |   |

 

7.               Consolidated Comprehensive Income

 

The following table presents the calculation of comprehensiveincome.  The components of comprehensiveincome for the periods ended June 30 are as follows, in thousands:

 
| ** **                                                                             | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                             | ** ** | **June 30**       | ** ** |
| ** **                                                                             | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Net income                                                                             |       | $                      | 1,202      |   | $ | 2,863 |   |
| Unrealized  gains (losses) on investments classified as available for sale, net of tax |       | 89                     |       | (167 | ) |
| Comprehensive  income                                                                  |       | $                      | 1,291      |   | $ | 2,696 |   |

 

8.               SegmentInformation

 

The Company follows the provisions of SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information.”  SFAS No. 131 establishes annual andinterim reporting standards for an enterprise’s business segments and relateddisclosures about its products, services, geographic areas and major customers.  The method for determining what informationto report is based upon the way management organizes the operating segmentswithin the Company for making operating decisions and assessing financial performance.  Operating segment information for Mesaba, BigSky and Holdings for the periods ended June 30 were asfollows, in thousands:

 

12

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| ** **                              | ** ** | ** ** | ** ** | ** **  | ** ** | **Holdings and** | ** ** | ** **       | ** ** |
|-----------------------------------------|------------|------------|------------|-------------|------------|------------------|------------|------------------|------------|
| ** **                              | ** ** | **Mesaba** | ** ** | **Big Sky** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Three Months  Ended June 30, 2005: |       |       |       |        |       |             |       |             |       |
| Operating  revenues                     |       | $          | 113,899    |        | $          | 4,540            |       | $                | —     |   | $ | 118,439 |   |
| 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            |       |
| Total assets  at end of period          |       | 116,545    |       | 11,488      |       | 150,701          |       | 278,734          |       |
| Three Months  Ended June 30, 2004: |       |       |       |        |       |             |       |             |       |
| Operating  revenues                     |       | 106,090    |       | 3,609       |       | —           |       | 109,699          |       |
| Depreciation  and amortization          |       | 3,542      |       | 207         |       | 4                |       | 3,753            |       |
| Interest  expense                       |       | —     |       | 77          |       | (59              | )          | 18               |       |
| Income  (loss) before income taxes      |       | 2,646      |       | (1,089      | )          | 1,334            |       | 2,891            |       |
| Capital  expenditures                   |       | 2,936      |       | 35          |       | —           |       | 2,971            |       |
| Total assets  at end of period          |       | 122,684    |       | 10,097      |       | 131,003          |       | 263,784          |       |
|                                         |            |            |            |             |            |                  |            |                  |            |  |  |  |  |

 

9.               Nonoperating Income

 

In the first quarter of fiscal 2006, the Company recognized $1.8million as nonoperating income as a result of a favorable arbitrationsettlement with a former investment advisor.

 

10.         Income Taxes

 

During the first quarter of fiscal 2005, the Company receivedverification of a final settlement with the Internal Revenue Service (“IRS”)concerning the IRS’ examination of the Company’s fiscal 1995 and 1996 incometax returns.  As a result of thissettlement, the Company reduced its income tax payable and tax provision by$1.2 million in the first quarter of fiscal 2005.

 

11.         Commitments andContingencies

 

On October 4, 2002, Fairbrook Leasing, Inc., Lambert Leasing, Inc.and Swedish Aircraft Holdings AB (“Saab Leasing”) filed a declaratory judgmentaction against Mesaba relating to 20 Saab 340A (“340A”) aircraft leased byMesaba.  Saab Leasing sought a judicial declaration that the terms of theleases applicable to each of the 340A aircraft are governed by a March 7,1996 term sheet proposal rather than the parties’ subsequent agreements andconduct.  In a December 8, 2003 order, the District Court declaredthe term sheet proposal a binding preliminary agreement requiring Mesaba tonegotiate in good faith toward the execution of long-term agreements for eachof the 340A aircraft.  Mesaba appealed the District Court’s ruling.

 

On August 13, 2004, relying on the District Court’s declaratoryjudgment ruling, Saab Leasing filed a separate action in the District Courtalleging approximately $35 million in damages for past due and future aircraftlease obligations.  Mesaba denies the allegations in Saab Leasing’scomplaint and contends that it has fulfilled and will continue to fulfill itsexisting obligations.

 

On May 19, 2005, the U.S. Court of Appeals for the Eighth Circuitaffirmed the District Court’s declaratory judgment ruling.  Despite theEighth Circuit’s ruling, Mesaba believes, based on advice from its legalcounsel, that it has defenses in the damages case that will limit Saab Leasing’sability to recover damages.  Nevertheless, there can be no assurance thatthe District Court in the damages case will agree with Mesaba’s analysis. Therefore, the ultimate outcome of this dispute cannot be predicted withcertainty.

 

As of June 30, 2005, the Company did not establish an accrual withregard to this litigation.  Accordingly,an adverse outcome to this matter could have a material impact on the Company’sfinancial condition and results of operation.

 

12.         New Accounting Pronouncements

 

InDecember 2004, the FASB issued SFAS 123(R), “Share-Based Payment,” which requires all public companiesaccounting for share-based payment transactions to account for these types oftransactions using a fair-value-based method.

 

13

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SFAS 123(R)eliminates the ability to account for share-based compensation transactionsusing APB Opinion No. 25. SFAS 123(R) also requires the tax benefits associated with theseshared-based payments to be classified as financing activities in the statementof cash flows rather than operating activities as is currently permitted.  SFAS No. 123(R) becomes effective asof the beginning of the first****fiscal year beginning after June 15,2005.

 

TheCompany expects to adopt SFAS No. 123(R) on April 1, 2006 using themodified-prospective method.  Under thistransition method, the Company will record compensation expense for all awardsit grants on a straight-line basis over the vesting period.  In addition, the Company will recordcompensation expense for the unvested portion of previously granted awards thatremain outstanding at the date of the adoption. The Company has not completed its assessment of the impact of thestandard on its financial condition or results of operations.

 

13.         Restatement

 

Subsequentto the issuance of its consolidated financial statements for the year ended March 31,2004, the Company determined that it had incorrectly accounted for certainaircraft leases that contained reduced rent obligations over a portion of thelease term.  This resulted in anunderstatement of other assets, net, other noncurrent liabilities and aircraftrents and an overstatement of retained earnings, shareholders’ equity and netincome in prior periods.  Although theCompany does not believe that this error resulted in a material misstatement ofthe Company’s consolidated financial statements for any prior periods, theeffects of correcting the error as of December 31, 2004, would have had amaterial effect on the Company’s results of operations for that period.  As a result, the condensed consolidatedfinancial statements for the quarter ended June 30, 2004 have beenrestated from the amounts previously reported.

 

Asummary of the significant effects of the restatement on the Company’sfinancial statements for June 30, 2004 is as follows, in thousands, exceptper share information:

 
| ** **                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **June 30, 2004** | ** ** |
| ** **                                | ** ** | **As Previously**      | ** ** | **As** | ** ** |
| ** **                                | ** ** | **Reported**           | ** ** | **Restated** | ** ** |
| Consolidated  balance sheets:             |       |                   |       |   |   |
| Other  assets, net                        |       | $                      | 7,482      |   | $ | 7,958 |   |
| Total assets                              |       | 263,308                |       | 263,784 |   |
| Other  noncurrent liabilities             |       | 5,889                  |       | 7,077 |   |
| Retained  earnings                        |       | 118,091                |       | 117,379 |   |
| Total  shareholders’ equity          |       | 187,751                |       | 187,039 |   |
| Statements  of operations:                |       |                   |       |   |   |
| Aircraft  rents                           |       | 25,032                 |       | 25,106 |   |
| Total  operating expenses                 |       | 107,101                |       | 107,175 |   |
| Operating  income                         |       | 2,598                  |       | 2,524 |   |
| Income  before provision for income taxes |       | 2,965                  |       | 2,891 |   |
| Net income                                |       | 2,907                  |       | 2,863 |   |
| Earnings per  common share - basic        |       | 0.14                   |       | 0.14 |   |
| Earnings per  common share - diluted      |       | 0.14                   |       | 0.14 |   |
|                                           |            |                        |            |  |  |  |  |

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operationshas been updated to give effect to the restatement as discussed in Note 13to the condensed consolidated financial statements included in Item 1, andshould be read in conjunction with the accompanying condensed consolidatedfinancial statements.  The Company’soperations and financial results are subject to various risks and uncertaintiesassociated with the airline industry.  See“Certain Risk Factors Relating to the Company and the Airline Industry” at theend of this Item 2.

 

14

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RESULTS OF OPERATIONS

 

**Three Months Ended June 30, 2005 and 2004**

The Company’s consolidated net income for the quarter ended June 30,2005 was $1.2 million, or $0.06 per diluted share, compared with net income of$2.9 million, or $0.14 per diluted share, for the quarter ended June 30,2004.  Comparative information onoperations for the three months ended June 30 was as follows:

 

***Mesaba***

Mesaba’s operating statistics for the three months ended June 30were as follows:

 
| ** **                      | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|---------------------------------|------------|-----------|------------|-----------|------------|
| Passengers                      |       | 1,501,045 |       | 1,396,338 |       |
| Available  seat miles (000s)    |       | 766,019   |       | 714,715   |       |
| Revenue  passenger miles (000s) |       | 514,809   |       | 480,199   |       |
| Load factor                     |       | 67.2      | %          | 67.2      | %          |
| Block hours  flown              |       | 71,734    |       | 68,863    |       |
| Departures                      |       | 53,037    |       | 50,421    |       |
| Revenue per  ASM                |       | $         | 0.149      |      | $          | 0.148 |   |
| Cost per ASM                    |       | $         | 0.149      |      | $          | 0.145 |   |
| Aircraft in  service (average)  |       | 98        |       | 97        |       |

 

Mesaba Operating Revenues  Totaloperating revenues increased 7.4% in the first quarter of fiscal 2006 to $113.9million from $106.1 million in the prior year quarter.  The increase isattributed to: $3.0 million from a 9.4% increase in RJ-85 flying due to thereturn to service of 5 RJ-85s that had been grounded in the prior year; $3.0million due to a 2.3% increase in additional Saab ASMs and an increase in theSaab reimbursement rate quarter over quarter; and $1.8 million in additionalground handling revenue in Detroit and Minneapolis/St. Paul.

 

Mesaba Operating Expenses  Total operating expenses increased 10.3% inthe first quarter of fiscal 2006 to $114.0 million from $103.4 million in theprior year quarter.  The increase inexpenses was due to the additional RJ85 and Saab flying and $2.4 million instart up expenses associated with Mesaba adding the CRJ aircraft to its fleet.  Mesaba’s operating costs per ASM for thethree months ended June 30 were as follows:

 
| ** **                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
| Wages and  benefits            |       | 4.9      | ¢     | 4.8      | ¢     |
| Aircraft  fuel                 |       | 0.6      |       | 0.6      |       |
| Aircraft  maintenance          |       | 2.9      |       | 2.8      |       |
| Aircraft  rents                |       | 3.3      |       | 3.4      |       |
| Landing fees                   |       | 0.2      |       | 0.2      |       |
| Insurance  and taxes           |       | 0.2      |       | 0.2      |       |
| Depreciation  and amortization |       | 0.5      |       | 0.5      |       |
| Administrative  and other      |       | 2.3      |       | 2.0      |       |
| Total                          |       | 14.9     | ¢     | 14.5     | ¢     |

 

Wages and benefits increased 9.3% to $37.3 million in the first quarterof fiscal 2006 from $34.1 million in the prior year quarter, primarily due to increasedground handling wages from additional ground handling activity which did notresult in any additional ASMs, increased wages due to additional flying andincreased health and dental expense. These increases were partially offset by favorability quarter overquarter in costs associated with the 401(k) benefit plan due to increased costsin the prior year.

 

Aircraft fuel increased 3.0% to $4.7 million in the first quarter offiscal 2006 from $4.6 million in the prior year quarter primarily due to the1.5% increase in the number of Saab block hours flown.  Provisions of the Airlink Agreement with

 

15

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Northwest protect Mesaba from changes in fuel prices.  Mesaba’s actual cost of fuel, including taxesand pumping fees, was 83.5 cents per gallon for both periods.  Northwest is responsible for fuel for Mesaba’sRJ85 operations.

 

Aircraft maintenance, excluding wages and benefits, increased 11.7% to$22.1 million in the first quarter of fiscal 2006 from $19.7 million in the prioryear quarter, partially due to a 4.3% increase in total block hours.  The increase is also due to increased costsassociated with expendable parts and repair costs incurred to continue tomaintain the fleet as it ages.

 

Aircraft rents increased 2.8% to $25.2 million in the first quarter of fiscal2006 from $24.6 million in the prior year quarter due to the return to serviceof five RJ85 aircraft that were grounded in first quarter of fiscal 2005.

 

Landing fees decreased 5.9% to $1.6 million in the first quarter offiscal 2006 from $1.7 million in the prior year quarter due to a ratereduction in Detroit.  Northwest isresponsible for landing fees for Mesaba’s RJ85 operations.

 

Insurance and taxes decreased 4.9% to $1.7 million in the first quarterof fiscal 2006 from $1.8 million in the prior year quarter due primarily to a5% decrease in hull and passenger liability insurance rates.

 

Depreciation and amortization remained relatively constantquarter-over-quarter due to steady state operation.

 

Administrative and other expenses increased 33.6% to $17.9 million inthe first quarter of fiscal 2006 from $13.4 million in the prior year quarterprimarily due to increased consulting costs and training costs incurred for CRJcertification as well as higher ground handling costs.

 

***Big Sky***

Big Sky’s operating statistics for the three months ended June 30were as follows:

 
| ** **                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Passengers                      |       | 26,227   |       | 21,174   |       |
| Available  seat miles (000s)    |       | 17,139   |       | 15,241   |       |
| Revenue  passenger miles (000s) |       | 7,500    |       | 5,491    |       |
| Load factor                     |       | 43.8     | %          | 36.0     | %          |
| Block hours  flown              |       | 4,601    |       | 4,170    |       |
| Departures                      |       | 5,033    |       | 4,888    |       |
| Revenue per  ASM                |       | $        | 0.265      |     | $          | 0.237 |   |
| Cost per ASM                    |       | $        | 0.313      |     | $          | 0.305 |   |
| Aircraft in  service (average)  |       | 9        |       | 12       |       |

 

Big Sky Operating Revenues  Total operating revenues increased 25.8% to $4.5million in the first quarter of fiscal 2006 from $3.6 million in the prior yearquarter due to a $0.5 million quarter over quarter increase in passengerrevenue as a result of increased passengers and average passenger fares and a$0.3 million increase in EAS subsidies resulting from new service, increasedrates and improved operations.

 

Big Sky Operating Expenses  Total operating expenses increased 15.3% inthe first quarter of fiscal 2006 to $5.3 million from $4.6 million in the prioryear quarter due to an increased level of flying year over year and the impactof higher fuel prices.

 

***Consolidated***

Nonoperating Income (Expense)  Nonoperating income increased to $2.8 millionin the first quarter of fiscal 2006 from $0.4 million in the prior year quarterdue to a $1.8 million arbitration settlement with an investment advisor and interestincome that increased as a result of additional funds invested at higherinterest rates.

 

Provision for Income Taxes The Company’s effective tax rate was 36.0%in the first quarter of fiscal 2006 as compared to 1.0% in the prior year quarter.  The Company adjusts its effective tax ratequarterly based on forecasted operating results in the fiscal year.  The rate is affected principally by the level of nondeductible expensesrelative to projected taxable income.

 

16

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In the firstquarter of fiscal 2005, the Company reduced its income tax payable and taxprovision by $1.2 million as it received verification of a final settlementwith the IRS concerning its examination of the Company’s fiscal 1995 and 1996tax returns.  Without this adjustment,the Company’s effective tax rate would have been 42.4%.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash, cash equivalents and investments increased 1.0% to $172.6 millionat June 30, 2005 from $170.9 million at March 31, 2005.  The Company’s working capital increased to $108.0million with a current ratio of 2.4 at June 30, 2005 compared to workingcapital of $105.3 million and a current ratio of 2.3 at March 31, 2005.

 

Investments consist principally of municipal securities and areclassified as available-for-sale. Available-for-sale investments are reported at fair value withunrealized gains and losses excluded from operations and reported as a separatecomponent of shareholders’ equity, except for other-than-temporary impairments,which are reported as a charge to current operations and result in a new costbasis for the investment.  The Companyclassifies investments with an original maturity date of more than 90 days thatmature within one year as short-term and greater than one year as long-term.

 

Approximately $22.8 million or 82.4% of Mesaba’s accounts receivablebalance as of June 30, 2005 was due from Northwest, and this receivable isnot collateralized.  The Company’sbusiness is sensitive to events and risks affecting Northwest.  Northwest has incurred significant losses inthe last several years, including a net loss of $862 million in calendar 2004and a net loss of $683 million in the first two quarters of calendar 2005.  If Northwest continues to incur operatinglosses, it may be unable to fulfill its financial obligations, includingpayments due to Mesaba under the Airlink Agreement and Jet Agreement.  Loss of Mesaba’s affiliation with Northwestor Northwest’s failure to make timely payment of amounts owed to Mesaba or tootherwise materially perform under the Airlink or Jet Agreement for any reasonwould have a material adverse effect on the Company’s results of operations andfinancial condition.  For a detaileddiscussion of the Company’s risks related to Northwest, see “Certain RiskFactors Related to the Company and the Airline Industry” at the end of thisItem 2.

 

As of June 30, 2005, Mesaba’s fleet consisted of 98 aircraftcovered under operating leases with remaining terms of up to 11 years andaggregate monthly lease payments of approximately $8.5 million.  Mesaba leases or subleases its Saab aircraft,either directly from aircraft leasing companies or through Pinnacle AirlinesCorp. (“Pinnacle”), under operating leases with initial terms of up to sevenyears or through subleases with Northwest under operating leases with initialterms of up to 17 years.  Mesaba leasesits RJ85 aircraft from Northwest under operating leases with initial terms ofup to ten years.  The Company believesthat Mesaba’s revenues from the Airlink and Jet Agreements will continue to besufficient to fund its aircraft lease obligations.  If the Airlink Agreement terminates, the Company’sobligation to continue to pay Saab aircraft leases will simultaneouslyterminate.  Likewise, if the JetAgreement terminates, the Company’s obligation to continue to pay RJ85 aircraftleases will simultaneously terminate.

 

As of June 30, 2005, Big Sky’s operating fleet consisted of nine operatingaircraft and four nonoperating aircraft covered under operating leases withremaining terms of four months to 59 months and aggregate monthly leasepayments of approximately $0.2 million. Big Sky leases all of its aircraft. Five of the leases for two operating and three nonoperating aircraft,allow Big Sky to return the aircraft to the lessor upon the occurrence ofcertain events and contain purchase options. Funding of the monthly minimum lease payments is dependent on continuedpassenger boardings, Big Sky’s operations and potentially, funding from theCompany.

 

The Company’s aircraft operating leases do not contain any guaranteedlease residual provisions for which there would be a potential contingency atthe termination of the lease period.

 

The Company has historically relied on cash and cash equivalents,investments and internally generated funds to support its working capitalrequirements.  Absent adverse factorsoutside the control of the Company, management believes current liquidity andfunds from operations will provide adequate resources for meeting currentoperations and non-aircraft capital needs through the remainder of fiscal 2006.

 

Cash and cash equivalents increased 14.7% to $66.5 million at June 30,2005 from $58.0 million at March 31, 2005. A summary of cash flow activity is as follows:

 

*Operating Activities*

Net cash provided by operations for the three months ended June 30,2005 was $5.0 million.  The primarysource of cash was from operations, which generated $1.2 million of net income and$3.9 million of non-cash expenses, primarily depreciation and amortization.  The primary use of cash was $0.1 million ofnet payments for current operating items.

 

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*Investing Activities*

Net cash provided by investing for the three months ended June 30,2005 was $3.6 million.  The sources ofcash for investing activities were the net sales of short-term investments andoperating activities.  The primary usesof cash were the net purchases of short and long-term investments, includingvariable securities classified as cash equivalents and purchases of property,plant and equipment of $3.0 million.

 

*Financing Activities*

Net cash used by financing for the three months ended June 30,2005 was insignificant.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

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

 

Management believes that its estimates and assumptions are reasonable,based on information presently available; however, changes in these estimates,judgments and assumptions will occur as a result of future events, and,accordingly, actual results could differ from amounts estimated.

 

*Aircraft Property and Equipment*—Estimatedlives are used to record depreciation on aircraft property and equipment.  Aircraft utilization, Airlink and JetAgreement contractual lives, technology and changes in business strategy mayaffect the economic lives used to record depreciation by Mesaba or Big Sky.  The foregoing may also affect depreciationrates, impairment or both.  Management ofMesaba and Big Sky regularly review the estimated useful lives and salvagevalues for aircraft property and equipment.

 

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

 

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

 

*Goodwill and Other Intangible Assets*—The excess of the Big Sky purchase price overthe fair market value of the net assets acquired was allocated to certainidentifiable intangible assets, including Big Sky’s pilot labor contract andits air carrier certificate and goodwill. The recoverability of goodwill ($2.5 million) and otherintangible assets ($2.7 million) is evaluated annually, at a minimum, or on aninterim basis if events or circumstances indicate a possible inability torealize the carrying amounts.  Theevaluation includes future cash flow projections, strategic modeling and othermanagement assumptions.  During thefourth quarter of fiscal 2005, the Company completed its annual impairment testof goodwill and other intangible assets and determined that no impairmentcharge was necessary.

 

*Income Taxes*—The Company’s effective tax rate was 32.9%, 46.8% and 51.7% in fiscal2005, 2004 and 2003.  The Company’seffective tax rate is based on expected income, statutory tax rates and taxplanning opportunities available in the various jurisdictions in which theCompany operates.  In the event thatthere is a significant unusual or one-time item recognized, or expected to berecognized, in the Company’s operating results, the tax attributable to thatitem would be separately calculated and recorded at the same time as theunusual or one-time item.  Significantjudgment is required in determining the Company’s effective tax rate and inevaluating its tax positions.  TheCompany establishes reserves when, despite its belief that the tax return positionsare fully supportable, certain positions are likely to be challenged and maynot succeed.  The Company adjusts thesereserves in light of changing facts and circumstances, such as the closing of atax audit.  The effective tax rateincludes the impact of reserve provisions and changes to reserves that areconsidered appropriate, as well as related interest.  This rate is then applied to the Company’squarterly operating results.

 

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*Workers Compensation Insurance*—TheCompany estimates the ultimate cost of an on-the-job injury at the time of theinjury to determine its workers compensation insurance reserves.  The Company uses the services of itsinsurance carrier and outside broker to assist in determining the reservelevels.  Injury severity, cost of careand the insurance contract affect the ultimate cost and ultimate reservesrecorded.  Management of Mesaba and BigSky regularly review workers compensation activity with outside consultants forany changes in the workers compensation reserve.

 

*Health and Dental Insurance*—TheCompany estimates the amount of incurred but not reported health and dentalclaims to determine its health and dental insurance reserves.  The Company uses the services of its insurancecarrier and outside broker 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 and Big Sky regularlyreview health and dental claims activity with outside consultants for anychanges in the health and dental insurance reserve.

 

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

 

NEW ACCOUNTING PRONOUNCEMENTS

 

InDecember 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which requiresall public companies accounting for share-based payment transactions to accountfor these types of transactions using a fair-value-based method.  SFAS No. 123(R) eliminates theability to account for share-based compensation transactions using APB Opinion No. 25.  SFAS No. 123(R) also requires thetax benefits associated with these shared based payments to be classified asfinancing activities in the statement of cash flows rather than operatingactivities as is currently permitted. SFAS No. 123(R) becomes effective as of the beginningof the first****fiscal year beginning after June 15,2005.

 

TheCompany expects to adopt SFAS No. 123(R) on April 1, 2006 using themodified-prospective method.  Under thistransition method, the Company will record compensation expense for all awardsit grants on a straight-line basis over the vesting period.  In addition, the Company will recordcompensation expense for the unvested portion of previously granted awards thatremain outstanding at the date of the adoption. The Company has not completed its assessment of the impact of thestandard on its financial condition or results of operations.

 

**CertainRisk Factors Relating to the Company and the Airline Industry**

 

The Company’s operations and financial results are subject to variousrisks and uncertainties, some of which are described below.  The Company could also be adversely affectedby additional risks and uncertainties not presently known or believed to bematerial.

 

**Risks Related to the Mesaba’s AirlinkAgreement and Jet Agreement**

 

*Mesaba is dependent on its relationship withNorthwest as its major customer, and the loss of this relationship wouldsubstantially harm the Company’s financial results.*

 

During fiscal 2005, Northwest accounted for 92.7% of Mesaba’s operatingrevenues.  Additionally, Mesabaconsistently carries a receivable due from Northwest between $20 million to $30million that is not collateralized. Northwest has incurred significant losses in the last several years,including a net loss of $862 million in calendar 2004 and a net loss of $683million in the first two quarters of calendar 2005.  If Northwest continues to incur operatinglosses, it may be unable to fulfill its financial obligations and may be forcedto initiate bankruptcy proceedings.  Additionally,Northwest is in a thirty-day cooling off period with its mechanics, and themechanics could strike as soon as August 19, 2005.  Because Holdings has no commitment to fundMesaba’s operations, if Northwest defaults or otherwise fails to make a paymentto Mesaba and subsequently files for bankruptcy, Mesaba would hold an unsecuredprepetition bankruptcy claim that it may be unable to collect.  Further, all of Mesaba’s contracts withNorthwest would be at risk, as Northwest would have the option to accept orreject each of such contracts.  Northwestcould also attempt to renegotiate Mesaba’s contracts through bankruptcy.  In the event Northwest is unable to payMesaba, if Mesaba is unable to secure alternate financing, Mesaba could beforced to file for bankruptcy protection.

 

The Company’s business could also be adversely affected by events at Northwestoutside of bankruptcy, such as an inability by Northwest to reduce laborexpenses and other costs, continued and unsustainable operating losses atNorthwest, changes

 

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in Northwest’s business plan or model, employee strike or job actions,significant curtailment of service (and thus curtailment of the utilization of Mesaba’saircraft), continued volatility of fuel costs and terrorist events.  Loss of the Company’s business relationshipwith Northwest or Northwest’s failure to make timely payment of amounts owed tothe Company would have a material adverse effect on the Company’s operations,financial position and cash flows.

 

*In connection with the Company’s non-bindingletter of intent with Northwest, Mesaba has incurred, and will continue toincur, significant expenses in connection with bringing the CRJ aircraft intoits fleet, and it may not be reimbursed for these expenses if a definitiveagreement is not signed.*

 

The Company’s non-binding letter of intent with Northwest provides thatMesaba will place the first CRJ aircraft in service by October 15,2005.  Although the parties have not yetsigned a definitive agreement, Holdings and Mesaba have incurred approximately$2.7 million in expenses in the first fiscal quarter related to adding the CRJaircraft to its fleets, and these expenses will continue in the next severalmonths until all aircraft contemplated under the agreement are delivered andplaced into revenue service.  However, ifan agreement with Northwest is not finalized, there is no assurance that Mesabawill realize revenue in the future to offset these start-up expenses.

 

*If Mesaba’s Airlink Agreement or JetAgreement with Northwest is terminated, the Company could lose either or both ofits significant sources of revenue and earnings, Mesaba’s aircraft, access toairport facilities and the services Northwest provides.*

 

Any termination of the Airlink Agreement or Jet Agreement by Northwest,through bankruptcy or otherwise, would allow Northwest the right to terminateMesaba’s aircraft leases and subleases covered by the agreements.  Northwest would also be allowed to takeimmediate possession of the aircraft.  Asa result, the Company would have no significant sources of revenue or earnings.  Additionally, Mesaba risks losing the use ofNorthwest’s systems, airport facilities and other services that support Mesaba’soperations.  Mesaba may not be able tofind replacement services, or it may not be able to find such services on termsor conditions as favorable as those received from Northwest.

 

*Northwest has not guaranteed that it willgrow Mesaba’s regional fleet and Northwest could opt to utilize other regionalairlines.*

 

Neither the Airlink Agreement nor Jet Agreement provide that Mesaba’sfleet will grow beyond its existing size. Additionally, the agreements do not prohibit Northwest from contractingwith other regional airlines to provide the same services that Mesaba currentlyprovides.  Finally, the Company’s letterof intent with Northwest is non-binding, so there is no guarantee thatNorthwest will place the new CRJ aircraft with Mesaba.  Northwest currently has an airline servicesagreement with Pinnacle, and Pinnacle serves many of the same cities asMesaba.  Northwest could choose to expandits agreement with Pinnacle in competition with Mesaba.  Northwest could also choose to establishrelationships with other regional airlines.

 

*The Airlink Agreement and Jet Agreement placeconstraints on Mesaba’s ability to provide airline services to airlines otherthan Northwest.*

 

Both the Airlink Agreement and Jet Agreement provide that Mesaba cannotuse any of its officers, employees, facilities, equipment or aircraft that ituses to provide airline services to Northwest in any new operations withanother airline without the prior written consent of Northwest.  Any services provided to another airlinewould have to be provided by a subsidiary independent of Mesaba, and doing socould result in significant costs to the Company.

 

**Risks Related to the Company’s Business andOperations**

 

*The Company’s success is dependent on itsability to obtain all necessary aircraft, engines, parts and relatedmaintenance and support from various aircraft manufacturers and vendors.*

 

The Company is dependent on various aircraft manufacturers and othervendors to provide sufficient parts and related maintenance and supportservices on a timely basis. Additionally, the Company relies on various engine manufacturers forparts, repair and overhaul services and other types of support services.  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 the Company’sbusiness, financial condition and results of operations.

 

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*Because the Company is unable to pass alongincreased operating costs, the Company’s earnings will be negatively affectedas its fleets continue to age.*

 

As the Company’s fleet of aircraft age, the cost of maintaining theaircraft will likely increase.  Becausemany aircraft components are required to be replaced after specified numbers offlight hours or take-off and landing cycles, and because new aviationtechnology may be required to be retrofitted, the cost to maintain agingaircraft will generally exceed the cost to maintain newer aircraft.  Any material increase in such costs will havea material adverse effect on the Company’s business, financial condition andresults of operations.

 

*If Mesaba loses certain of its groundhandling business, the Company’s results of operations could be materiallyaffected.*

 

Mesaba performs various ground handling services for Northwest andPinnacle at Minneapolis, 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 Northwestor Pinnacle terminate Mesaba’s ground handling services, the Company’sfinancial results would be materially affected, both through a loss of revenueand increased transition expenses.

 

*The Company could incur significant costs ifit experiences difficulty finding, training and retaining employees.*

 

The Company’s business is labor-intensive, and the Company requireslarge numbers of pilots, flight attendants, maintenance technicians and otherpersonnel.  The airline industry has fromtime to time experienced a shortage of qualified personnel, specifically pilotsand maintenance technicians.  Inaddition, as is common with most of the Company’s competitors, the Company hasfaced turnover of its employees.  Forexample, the Company’s pilots, flight attendants and maintenance techniciansoccasionally leave to work for larger airlines, which generally offer highersalaries and more extensive benefit programs than regional airlines arefinancially able to offer.  In the eventof a significant increase in the turnover of employees, the Company would incursignificantly higher training costs than would otherwise be necessary.  The Company cannot provide assurance that itwill be able to recruit, train and retain the qualified employees it requiresto carry out its business plan.

 

*The Company could be adversely affected bythe highly competitive nature of the airline industry.*

 

The airline industry is highly competitive, and Northwest competes notonly with other regional carriers, but also with low-cost airlines and majorairlines on many of its routes, including the routes that Mesaba flies.  Some of these competitors are significantlylarger and possess greater resources than Northwest.  Moreover, any new entry in the markets Mesabaserves could lessen the economic benefits Northwest derives from servicingthese markets.  Finally, Big Sky alsocompetes with low-cost and regional carriers on its routes, and it faces thesame competitive challenges described above.

 

*The Company’s ability to diversify within theairline industry may be limited by the terms of various collective bargainingagreements and by other airlines’ business agreements.*

 

Mesaba’s labor collective bargaining agreement with its own pilotslimits the types of aircraft Big Sky may fly. Mesaba’s and Big Sky’s ability to provide regional service to othermajor air carriers may also be limited by those carriers’ existingrelationships with other regional operators. Additionally, many of the labor collective bargaining agreements ofmajor airlines, including Northwest, contain scope clause restrictions thatlimit the airlines’ ability to add new regional jets.  These factors could prevent the Company frompursuing future diversification opportunities.

 

*The Company’s compliance with various regulationsgoverning the airline industry can be costly, and the Company could be harmedif it fails to comply with such regulations.*

 

Airlines are subject to extensive regulatory and legal requirementsthat involve significant compliance costs that result in increased costs forpassengers and the Company.  The FAA, DOTand TSA periodically propose additional laws, regulations, taxes and airportrates and charges.  Such measures couldhave the effect of raising ticket prices, reducing revenue, increasing costs orreducing demand for air travel.  TheCompany expects to continue incurring expenses to comply with existing andfuture regulations.  Moreover, if theCompany fails to comply with applicable regulations, it may be subject tosanctions, including the following:

 

**•**                  warning letters;

**•**                  fines;

**•**                  injunctions;

 

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

**•**                  criminalprosecutions.

 

*Future terrorist attacks, other world events,general economic conditions and other factors beyond the Company’s controlcould substantially harm the Company.*

 

The terrorist attacks of September 11, 2001 and the prolongedunrest in the Middle East materially affected and continue to affect theairline industry.  Concerns about furtherterrorist attacks have had a negative impact on air travel demand.  In addition, security procedures introducedat airports since the attacks have increased the inconvenience of air travel,both in reality and in customer perception, leading to further reduction indemand.  Additional terrorist attacks,the fear of such attacks or continued conflict in Iraq or other countries couldfurther affect the airline industry and could cause general instability infinancial markets.

 

Because a substantial portion of air travel, including business travel,is discretionary, the industry tends to experience adverse financial resultsduring general economic downturns.  Softeconomic conditions continue to put pressure on the profitability of theindustry.  Any general decline inpassenger traffic may harm the Company’s business.

 

The Company’s operations are also subject to delays caused by factorsbeyond its control, including air traffic congestion at airports, adverseweather conditions and increased security measures.  Such delays frustrate passengers, reduceaircraft utilization and increase costs, all of which may affect profitabilityand harm the Company’s financial condition and results of operations.

 

*The Company is increasingly dependent upontechnology in its operations, and any failure of such technology couldadversely affect the Company.*

 

The Company has made, and will continue to make, substantialinvestments in technology to manage its operations.  In particular, the systems operations controlcenters, which oversee daily flight operations, are dependent on a number oftechnology systems to operate effectively. These technology systems may be vulnerable to various sources ofinterruption due to events beyond the Company’s control, including naturaldisasters, terrorist attacks, computer viruses and hackers.  In addition, large-scale interruption intechnology on which the Company depends, such as power, telecommunications orthe Internet, could substantially disrupt the Company’s operations.

 

*Any airline accident in which the Company isinvolved could subject the Company to substantial liability and seriously harmthe Company’s financial condition and results of operations.*

 

An accident involving Mesaba or Big Sky aircraft could result ininjuries and loss of life, and the Company could experience significant claimsfrom injured persons and surviving relatives. An accident could also result in substantial property damage, loss ofaircraft from service and adverse publicity for the Company.  Airlines are required by the DOT to carryliability insurance.  Although theCompany believes its liability insurance is in amounts and of the type generallyconsistent with industry practice, substantial claims resulting from anaccident in excess of insurance coverage would harm the Company’s business andfinancial results.  Any resulting claimswould also be costly to defend and could harm the Company’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.

 

*The Company is subject to collectivebargaining agreements with several of its employee groups, and any failure tosuccessfully negotiate these agreements could subject the Company to strikesand increased labor costs, either of which could negatively impact the Company’sfinancial performance.*

 

Labor costs are a significant component of the Company’s expenses,comprising 33.2% of total operating expenses in fiscal 2005.  Several of Mesaba’s and Big Sky’s employeegroups have separate bargaining agreements and may make demands that wouldincrease operating expenses, adversely affecting profitability.  Mesaba is currently negotiating with itsmechanics for a new agreement.  Theexisting agreement became amendable in August 2003.  Moreover, Mesaba’s mechanics are representedby the Aircraft Mechanics Fraternal Association, the same union to whichNorthwest’s mechanics belong.  Northwest’smechanics are in a 30-day cooling off period and could strike as soon as August 19,2005.  Although Mesaba’s mechanics have aseparate contract, the Company cannot guarantee that Mesaba’s mechanics willnot honor a Northwest strike or engage in other job actions in solidarity withNorthwest’s mechanics.  Mesaba is alsocurrently negotiating with its dispatchers, whose agreement became amendable inMay 2005.  The Company cannotpredict the outcome of these

 

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negotiations.  If Mesaba or BigSky is unable to reach agreement on the terms of any collective bargainingagreement or experiences widespread employee dissatisfaction, there could bework slowdowns or stoppages.  Anysustained work stoppages could adversely affect Mesaba’s ability tofulfill its obligations under the Airlink Agreement and Jet Agreement and couldhave an adverse effect on the Company’s financial condition and results ofoperations.

 

**Risks Related to the Company’s Stock**

 

*Together, certain of the Company’sshareholders own or have the right to acquire a significant portion of theCompany’s stock and could ultimately control decisions regarding the Company.*

 

Northwest owns 27.5% of the Company’s common stock.  Northwest also owns warrants to purchase anaggregate of 4,151,922 shares of the Company’s common stock.  Additionally, several other shareholders alsoown significant blocks of the Company’s common stock.  Because the parties described above currentlyown a large portion of the Company’s stock, they may be able to determine orsignificantly influence the outcome of corporate actions requiring shareholderapproval.  As a result, these parties maybe in a position to control matters affecting the Company, including decisionsas to the Company’s direction and policies; future issuances of securities;incurrence of debt; amendments to the Company’s articles of incorporation andbylaws; payment of dividends on the Company’s common stock; and acquisitions,sales of the Company’s assets, mergers or similar transactions, includingtransactions involving a change of control. As a result, some investors may be unwilling to purchase the Company’scommon stock.  In addition, if the demandfor the Company’s common stock is reduced because of these shareholders’control of the Company, the price of the Company’s common stock could bematerially depressed.

 

*Future sales of the Company’s common stock byits shareholders could depress the price of the Company’s stock.*

 

Sales of a large number of shares of the Company’s common stock or theavailability of a large number of shares for sale could adversely affect themarket price of the Company’s common stock. As of June 30, 2005, the Company had 20,574,340 shares of commonstock outstanding.  Several of theCompany’s shareholders own substantial 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 warrants. In connection with the letter of intent with Northwest, the Company hasagreed to enter into a registration rights agreement to register the shares ofstock owned by Northwest (including those shares underlying its warrants).  Following such registration, future sales ofthose shares, or future sales of other large blocks of the Company’s commonstock that are already registered, could substantially depress the Company’sstock price.

 

*Any future exercises of warrants by Northwestcould substantially dilute the Company’s common stock.*

 

As of June 30, 2005, Northwest held warrants exercisable for anaggregate of 4,151,922 shares of the Company’s common stock at prices rangingfrom $7.25 per share to $21.25 per share. As described in the previous “Recent Developments” section, if theCompany enters into an omnibus airline services agreement, it expects to amendthese warrants to change the exercise price to $8.74 per share and to decreasethe number of shares issuable upon exercise to 4,112,500 shares.  Holders of the Company’s common stock,therefore, could experience substantial ownership dilution if Northwest electsto exercise these warrants.

 

*The Company’s stock price may continue to bevolatile.*

 

In the past two fiscal years, the market price of the Company’s commonstock has ranged from a low of $5.52 per share to a high of $10.11 pershare.  Because the Company’s stock isthinly traded, its market price is sensitive and may continue to experiencesubstantial fluctuations due to a variety of factors, including the following:

 

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

**•**                  securitiesanalysts’ estimates;

**•**                  materialannouncements by the Company, Northwest or the Company’s competitors;

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

**•**                  regulatory actions;or

**•**                  general marketconditions.

 

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*Anti-takeover provisions of the Company’sarticles of incorporation and bylaws and of Minnesota law could discourage,delay or prevent a change in control.*

 

The Company’s articles of incorporation and bylaws, along withMinnesota law, could discourage, delay or prevent persons from acquiring orattempting to acquire the Company.  TheCompany’s articles of incorporation authorize the board of directors, withoutaction by the Company’s shareholders, to designate and issue preferred stock inone or more series, with such rights, preferences and privileges as the boardof directors shall determine.  TheCompany’s articles of incorporation and bylaws also mandate a classified boardof directors, which makes changing control of the board more difficult.  The Company’s bylaws grant the board ofdirectors the authority to adopt, amend or repeal all or any of such bylaws,subject to the power of the shareholders to change or repeal such bylaws.  The Company’s bylaws also limit who may callmeetings of the Company’s shareholders.

 

As a public corporation, the Company is prohibited by the MinnesotaBusiness Corporation Act, except under certain specified circumstances, fromengaging in any merger, significant sale of stock or assets or businesscombination with any shareholder or group of shareholders who own at least 10%of the Company’s common stock.

 

**ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

The Company’s principal market risks are the availability and price ofjet fuel and changes in interest rates.

 

The Company believes its arrangements for fuel, primarily withNorthwest, assure an adequate supply of fuel for current and future operationsfor both Mesaba and Big Sky, provided that Northwest does not experience asupply shortage.  As a part of theAirlink Agreement, Northwest bears the economic risk of fuel price fluctuationsfor Mesaba’s fuel requirements.  As partof the Jet Agreement, Northwest provides all fuel at its expense to supportMesaba’s RJ85 operations.  Big Sky issubject to fluctuations in fuel prices, but currently fuel expense is not amaterial cost in relation to the Company’s total operating expenses.  The Company expects that its results ofoperations will not be materially affected by fuel price volatility.

 

The Company does not hold long-term interest-sensitive assets andtherefore is not exposed to significant interest rate fluctuations for itsassets.  The Company does not purchase orhold any derivative financial instruments for trading or speculative purposes.

 

**ITEM 4. CONTROLS AND PROCEDURES**

 

*Evaluation of Disclosure Controls Procedures*

As of June 30, 2005, the Company conducted an evaluation under thesupervision and with the participation of the Company’s management, includingthe Company’s Chief Executive Officer and Chief Financial Officer, regardingthe effectiveness of the design and operation of the Company’s disclosurecontrols and procedures (as that term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended).  Based upon that evaluation, the ChiefExecutive Officer and Chief Financial Officer concluded that the Company’sdisclosure controls and procedures are effective as of the date of suchevaluation.

 

*Changes in Internal Controls*

During the quarter ended June 30, 2005, there were no changes ininternal controls over financial reporting that had a material affect oninternal control over financial reporting or were reasonably likely to have amaterial effect on internal control over financial reporting.

 

TheCompany’s management doesnot expect that its disclosure controls and procedures will prevent all errorsand all fraud. A control system, no matter how well conceived and operated, canprovide only reasonable, not absolute, assurance that the objectives of thecontrol system are met. Because of the inherent limitations in all controlsystems, no evaluation of controls can provide absolute assurance that allcontrol issues and instances of fraud, if any, within the Company have beendetected. The design of any system of controls also is based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions; over time, control may become inadequate becauseof changes in conditions, or the degree of compliance with the policies orprocedures may deteriorate. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

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**Part II.  OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

Incorporated by reference to Note 11, “Commitments and Contingencies”of the Company’s Notes to Condensed Consolidated Financial Statements,contained in Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

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**ITEM 6. EXHIBITS**

 
| **Exhibit  Number** | ** ** | **Document Description**                                                                                                                                                                                                                                                                                                                                                                                                         |
|---------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                             |
| 3.1                 |       | Amended and Restated Articles of  Incorporation. Incorporated by reference to Exhibit 4.1 to the Company’s  Form 8-K filed on August 27, 2003.                                                                                                                                                                                                                                                               |
| 3.2                 |       | Bylaws. Incorporated by reference to Exhibit 3.2  to the Company’s Form 10-K filed June 14, 2005.                                                                                                                                                                                                                                                                                                            |
| 4.1                 |       | Specimen certificate for shares of the  Common Stock of the Company. Incorporated by reference to Exhibit 4.2 to  the Company’s Form 8-K filed August 27, 2003.                                                                                                                                                                                                                                              |
| 4.2                 |       | Common Stock Purchase Warrant dated October 25,  1996 issued to Northwest Airlines, Inc. Incorporated by reference to Exhibit 4A  to the Company’s 10-Q for the quarter ended September 30, 1996.                                                                                                                                                                                                       |
| 4.3                 |       | Common Stock Purchase Warrant dated October 17,  1997 issued to Northwest Airlines, Inc. Incorporated by reference to Exhibit 4A  to the Company’s 10-Q for the quarter ended September 30, 1997.                                                                                                                                                                                                       |
| 4.4                 |       | Common Stock Purchase Warrant dated April 1,  1998 issued to Northwest Airlines, Inc. Incorporated by reference to Exhibit 4A  to the Company’s 10-Q for the quarter ended June 30, 1998.                                                                                                                                                                                                               |
| 4.5                 |       | Common Stock Purchase Warrant dated June 2,  1998 issued to Northwest Airlines, Inc. Incorporated by reference to Exhibit 4B  to the Company’s 10-Q for the quarter ended June 30, 1998.                                                                                                                                                                                                                |
| 10.1                |       | 1994 Stock Option Plan. Incorporated by  reference to Exhibit 10.1 to the Company’s Form 10-K filed June 14,  2005.                                                                                                                                                                                                                                                                                          |
| 10.2                |       | 1996 Directors’ Option Plan. Incorporated  by reference to Exhibit 10.2 to the Company’s Form 10-K filed June 14,  2005.                                                                                                                                                                                                                                                                                |
| 10.3                |       | 2000 Stock Incentive Plan. Incorporated by  reference to Exhibit 10.3 to the Company’s Form 10-K filed June 14,  2005.                                                                                                                                                                                                                                                                                       |
| 10.4                |       | Mesaba Aviation, Inc. 2003 Incentive  Award Plan. Incorporated by reference to Exhibit 10.4 to the Company’s Form 10-K  filed June 14, 2005.                                                                                                                                                                                                                                                            |
| 10.5                |       | Airline Services Agreement between Mesaba  Aviation, Mesaba Holdings, Inc. and Northwest Airlines, Inc. dated July 1,  1997 (certain potions of this agreement are subject to an order granting  confidential treatment pursuant to Rule 24b-2). Incorporated by  reference to Exhibit 10A to the Company’s Form 10-Q for the quarter  ended September 30, 1997.                         |
| 10.6                |       | Regional Jet Services Agreement between  Mesaba Holdings, Inc., Mesaba Aviation, Inc. and Northwest Airlines, Inc.,  dated October 25, 1996 (certain provisions of this agreement are subject  to an order granting confidential treatment pursuant to Rule 24b-2).  Incorporated by reference to Exhibit 10A to the Company’s Form 10-Q  for the quarter ended September 30, 1996. |
| 10.7                |       | Special Facilities Lease dated as of August 1,  1990 between Charter County of Wayne, State of Michigan and Mesaba Aviation, Inc.  Incorporated by reference to Exhibit 10B to the Company’s Form 10-Q  for the quarter ended September 30, 1990.                                                                                                                                                  |
| 10.8                |       | Ground Lease dated August 1, 1990  between Charter County of Wayne, State of Michigan and Mesaba Aviation, Inc.  Incorporated by reference to Exhibit 10C to the Company’s Form 10-Q  for the quarter ended September 30,1990.                                                                                                                                                                     |
| 10.9                |       | Letter Agreement dated December 24,  1992 relating to the repurchase of shares of Common Stock from Northwest  Aircraft, Inc. Incorporated by reference to Exhibit 10EE to the  Company’s Form 10-K for the year ended March 31, 1993.                                                                                                                                                             |
| 10.10               |       | Stock Purchase Agreement between the  Company and Carl R. Pohlad dated as of October 18, 1993. Incorporated by  reference to Exhibit 10.10 to the Company’s Form 10-K filed June 14,  2005.                                                                                                                                                                                                             |
| 10.11               |       | Term Sheet Proposal for the Acquisition of  Saab 340 Aircraft by Mesaba Aviation, Inc. dated March 7, 1996  (certain portions of this document have been deleted pursuant to an  application for confidential treatment under Rule 24b-2). Incorporated  by reference to Exhibit 10U to the Company’s Form 10-K/A for the  year ended March 31, 1996.                                         |

 

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| **Exhibit  Number** | ** ** | **Document Description**                                                                                                                                                                                                                                                                                                                                                                                                                               |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.12               |       | Letter Agreement regarding Saab 340B Plus  Acquisition Financing dated March 7, 1996 (certain portions of this  document have been deleted pursuant to an application for confidential  treatment under Rule 24b-2). Incorporated by reference to Exhibit 10V  to the Company’s Form 10-K/A for the year ended March 31, 1996.                                                                                           |
| 10.13               |       | Letter Agreement of October 25, 1996  relating to Regional Jet Services Agreement between Mesaba Aviation, Inc.  and Northwest Airlines, Inc. (certain portions of this document have  been deleted pursuant to an application for confidential treatment under Rule 24b-2).  Incorporated by reference to Exhibit 10A to the Company’s Form 10-Q/A  for the quarter ended September 30, 1996.                 |
| 10.14               |       | Amendment No. 1 to Regional Jet  Services Agreement dated April 1, 1998 between Mesaba Holdings, Inc.,  Mesaba Aviation, Inc. and Northwest Airlines, Inc. (certain  portions of this document have been deleted pursuant to an application for  confidential treatment under rule 24b-2). Incorporated by reference to Exhibit 10A  to the Company’s Form 10-Q for the quarter ended June 30, 1998. |
| 10.15               |       | Amendment No. 2 to Regional Jet  Services Agreement dated June 2, 1998 between Mesaba Holdings, Inc.,  Mesaba Aviation, Inc. and Northwest Airlines, Inc. (certain  portions of this document have been deleted pursuant to an application for  confidential treatment under rule 24b-2). Incorporated by reference to Exhibit 10B  to the Company’s Form 10-Q for the quarter ended June 30, 1998.  |
| 10.16               |       | Lease Agreement, dated as of July 1,  1999, between Kenton County Airport Board and Mesaba Aviation, Inc.  Incorporated by reference to Exhibit 10AA to the Company’s Form 10-K  for the year ended March 31, 2000.                                                                                                                                                                                                      |
| 10.17               |       | Ground Lease, dated as of September 1,  1999, between Kenton County Airport Board and Mesaba Aviation, Inc.  Incorporated by reference to Exhibit 10BB to the Company’s Form 10-K  for the year ended March 31, 2000.                                                                                                                                                                                                    |
| 10.18               |       | Letter Agreement, dated November 20,  2001, between Mesaba Holdings, Inc., Mesaba Aviation, Inc. and  Northwest Airlines, Inc. relating to service expansion and rate  reductions. Incorporated by reference to Exhibit 10.1 to the Company’s Form 8-K  filed November 23, 2001.                                                                                                                               |
| 10.19               |       | Aircraft Hangar Facility Lease Agreement  between Metropolitan Airports Commission Minneapolis — St. Paul and Mesaba  Aviation, Inc. dated September 30, 2002. Incorporated by reference  to Exhibit 10Y to the Company’s Form 10-Q for the quarter ended June 30,  2003.                                                                                                                                           |
| 10.20               |       | Lease between Spectrum Investment Group,  L.L.C. and Mesaba Aviation, Inc. entered into as of April 25, 2003.  Incorporated by reference to Exhibit 10Z to the Company’s Form 10-Q  for the quarter ended June 30, 2003.                                                                                                                                                                                                 |
| 10.21               |       | Amendment to Regional Jet Services  Agreement by and among MAIR Holdings, Inc., Mesaba Aviation, Inc.  and Northwest Airlines, Inc., dated October 7, 2003. Incorporated  by reference to Exhibit 10.1 to the Company’s Form 8-K/A filed October 9,  2003.                                                                                                                                                     |
| 10.22               |       | Amendment to Regional Jet Services  Agreement by and among MAIR Holdings, Inc., Mesaba Aviation, Inc.  and Northwest Airlines, Inc., dated December 15, 2003. Incorporated  by reference to Exhibit 10.1 to the Company’s Form 8-K filed on December 15,  2003.                                                                                                                                                |
| 10.23               |       | Amendment to Regional Jet Services  Agreement by and among MAIR Holdings, Inc., Mesaba Aviation, Inc.  and Northwest Airlines, Inc., dated February 2, 2004. Incorporated  by reference to Exhibit 10.1 to the Company’s Form 8-K filed February 3,  2004.                                                                                                                                                     |
| 10.24               |       | Management Compensation Agreement between  the Company and Paul F. Foley, dated October 1, 2004. Incorporated by  reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K  filed on October 22, 2004.                                                                                                                                                                                                           |
| 10.25               |       | Amendment to Airline Services Agreement by  and among MAIR Holdings, Inc., Mesaba Aviation, Inc. and Northwest  Airlines, Inc., dated April 15, 2005 (certain portions of this  document have been deleted pursuant to an application for confidential  treatment under rule 24b-2). Incorporated by reference to Exhibit 10.25  to the Company’s Form 10-K filed June 14, 2005.                          |
| 10.26               |       | Amendment to Regional Jet Services  Agreement by and among MAIR Holdings, Inc., Mesaba Aviation, Inc.  and Northwest Airlines, Inc., dated April 15, 2005 (certain  portions of this document have been deleted pursuant to an application for  confidential treatment under rule 24b-2). Incorporated by reference to Exhibit 10.26  to the Company’s Form 10-K filed June 14, 2005.                     |
| 31.1                |       | Chief Executive Officer Certification  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Filed  herewith.                                                                                                                                                                                                                                                                                                                                |

 

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| **Exhibit  Number** | ** ** | **Document Description**                                                                                                |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                    |
| 31.2                |       | Chief Financial Officer Certification  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Filed  herewith. |
| 32.1                |       | Certification Pursuant to Section 906  of the Sarbanes-Oxley Act of 2002. Filed herewith.                          |

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf of theundersigned, thereunto duly authorized.

 
|                       | MAIR Holdings, Inc.                                                                                          |
|----------------------------|-------------------------------------------------------------------------------------------------------------------|
|                       |                                                                                                              |   |
|                       |                                                                                                              |   |
| Dated: August 9, 2005 | By:                                                                                                               | /s/ Robert E. Weil |   |
|                       | Robert E. Weil                                                                                                    |
|                       | Vice President, Chief Financial Officer and  Treasurer  (principal financial officer and an authorized signatory) |

 

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