UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-K

 

(Mark One)

x        ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended March 31, 2006

or

 

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

 

For the transition period from          to             

 

Commission File No. 0-17895

 

MAIR HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

 

150 South Fifth Street, Suite 1360

Minneapolis, Minnesota  55402

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code:  (612) 333-0021

Securities registered pursuant to Section 12(b) of the Act:  None

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

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

 

Yes  o     No  x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

 

Yes  o     No  x

 

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

 

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

 

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

 

Large accelerated filer o

Accelerated filer x

Non-accelerated filer o

 

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

 

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

 

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

 

DOCUMENTS INCORPORATED BY REFERENCE

 

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

 

 

 

MAIR HOLDINGS, INC.

Annual Report on Form 10-K

For the Fiscal Year Ended March 31, 2006

 

TABLE OF CONTENTS

 

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

 

 

i

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Statements in this Annual Report on Form 10-K of MAIR Holdings, Inc. (“Holdings” or the “Company”) under the caption “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report are forward-looking and are based upon information currently available to the Company.  The Company, through its officers, directors or employees, may also from time to time make oral forward-looking statements.  In connection with the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, the Company is hereby identifying important factors that could cause actual results to differ materially from those contained in any forward-looking statement made by or on behalf of the Company.  Many important factors that could cause such a difference, including those surrounding Mesaba Aviation, Inc.’s bankruptcy proceedings, are described in “Item 1A.  Risk Factors” in this Annual Report on Form 10-K.

 

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

 

All subsequent written or oral forward-looking statements attributable to the Company or persons acting on the Company’s behalf are expressly qualified by the factors described above.  The Company assumes no obligation, and disclaims any obligation, to update information contained in this Annual Report on Form 10-K, including forward-looking statements, as a result of facts, events or circumstances after the date of this report, except as required by law in the normal course of its public disclosure practices.

 

 

1

 

PART I

 

Item 1.  BUSINESS

 

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

 

Operations

 

Mesaba

Mesaba Bankruptcy

On October 13, 2005 (the “Petition Date”), Mesaba voluntarily filed in the United States Bankruptcy Court for the District of Minnesota (the “Bankruptcy Court”) for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code.  Mesaba’s bankruptcy filing was a direct result of events leading up to and following the bankruptcy filing by Northwest Airlines, Inc. (“Northwest”) on September 14, 2005.  Northwest is Mesaba’s major customer, and as a result of Northwest’s missed payments to Mesaba before and after Northwest’s bankruptcy filing, Mesaba estimates that Northwest owes Mesaba approximately $29.1 million as of March 31, 2006 under the various agreements between the parties, net of amounts that Mesaba owed to Northwest under these agreements.  Northwest has also proposed and made several significant fleet changes that have resulted in Mesaba operating a substantially reduced fleet.

 

Northwest’s missed payments to Mesaba and Northwest’s actions regarding its fleet and schedule changes adversely affected Mesaba, and Mesaba determined that it could not sustain its operations outside of court protection under Chapter 11 of the Bankruptcy Code.  Since the Petition Date, Mesaba has continued, and will continue, to operate its business as a debtor-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code, the Federal Rules of Bankruptcy Procedure and applicable court orders.  In general, as a debtor-in-possession, Mesaba is authorized under Chapter 11 to continue to operate as an ongoing business, but may not engage in transactions outside the ordinary course of business without the prior approval of the Bankruptcy Court.  All of Mesaba’s vendors are being paid for all goods furnished and services provided to Mesaba after the Petition Date in the ordinary course of business.  However, under Section 362 of the Bankruptcy Code, actions to collect most of Mesaba’s prepetition liabilities are automatically stayed.

 

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

 

•                  restructuring its costs to realize savings, including both labor and non-labor contracts related to its operations;

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

•                  affirming Mesaba’s relationship with Northwest.

 

 

2

 

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

 

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

 

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

 

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

 

Mesaba’s estimate of its liability for prepetition general unsecured claims is reflected in Mesaba’s “liabilities subject to compromise.”  Mesaba’s deconsolidated balance sheet at March 31, 2006 includes $60.0 million in liabilities subject to compromise.  See “Item 8. Financial Statements and Supplemental Data, Note 20 — Financial Information of Mesaba” for additional information.  Mesaba expects its liabilities subject to compromise to change in the future as a result of future negotiations with creditors or damage claims created by Mesaba’s rejection of various aircraft leases, executory contracts and unexpired leases.  Generally, if Mesaba assumes an aircraft financing agreement, executory contract or unexpired lease, Mesaba is required to provide for a cure for existing defaults under such contract or lease as a condition to such assumption.

 

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

 

 

3

 

Mesaba and the remaining three unions for Mesaba’s pilots, mechanics and flight attendants in February and March 2006.  On May 18, 2006, the Bankruptcy Court denied Mesaba’s motion to reject.  Although the Bankruptcy Court agreed with Mesaba’s core business assumptions, the court ruled that Mesaba failed to satisfy certain technical elements required to authorize rejection of the labor contracts under Section 1113.  The Bankruptcy Court stated that if Mesaba chooses to remedy the defects in its original motion, the court would hear a renewed motion in a prompt manner.  On June 12, 2006, Mesaba filed a renewed motion for authority to reject its CBAs, and the Bankruptcy Court began hearing the motion on June 26, 2006.  There can be no assurance that Mesaba will ultimately obtain the labor cost savings it requires to successfully reorganize.

 

Pursuant to Mesaba’s request for debtor-in-possession financing, in October 2005, Holdings provided a commitment letter and term sheet to Mesaba for such financing.  At Mesaba’s request, Holdings extended the deadline for the expiration of the commitment letter two times.  On March 24, 2006, the commitment expired.  Mesaba is seeking debtor-in-possession financing from other sources, but there can be no assurance that Mesaba will be able to obtain such financing on acceptable terms.  If Mesaba is unable to obtain debtor-in-possession financing by the end of the second quarter of fiscal 2007, Mesaba may not have sufficient cash to continue to fund its operations.

 

To successfully emerge from Chapter 11, the Bankruptcy Court must confirm a plan of reorganization, the filing of which will depend on the timing and outcome of numerous ongoing matters in the Chapter 11 process, potentially including the outcome of Northwest’s Chapter 11 case.  The reorganization plan will be subject to a vote by certain classes of creditors, including Mesaba’s secured creditors and unsecured creditors.  The Bankruptcy Court will generally not approve a reorganization plan unless all impaired classes of creditors vote to accept the plan; however, Mesaba may elect to invoke certain provisions of the Bankruptcy Code in order to obtain confirmation of the plan over the vote of a dissenting class of creditors.  In addition to the voting requirements for confirmation, Mesaba will have to satisfy other provisions of the Bankruptcy Code in order to confirm its reorganization plan, including showing that the plan is feasible.  Additionally, the absolute priority rule in the Bankruptcy Code requires that all of the debtor’s creditors must be paid in full; otherwise the equity holders in the debtor are not entitled to retain their equity interests, unless certain exceptions to the absolute priority rule are met.

 

Mesaba had the exclusive right for 120 days from the Petition Date to file a plan of reorganization, followed by 60 days in which to obtain acceptance of the plan.  On March 9, 2006, the Bankruptcy Court approved a motion filed by Mesaba to extend the deadline for Mesaba’s exclusive right to file such a plan to August 10, 2006.  Mesaba intends to file a plan of reorganization as soon as it is able, but there can be no assurance that a reorganization plan will be proposed by Mesaba within the required time frame or that any additional extensions Mesaba may request will be approved.  Additionally, there can be no assurance that the Bankruptcy Court will confirm any plan of reorganization proposed by Mesaba or that any such plan will be implemented successfully.  The reorganization plan will determine the rights and claims of various creditors and security holders.  At this time, it is not possible to predict accurately the effect of the Chapter 11 reorganization process on Mesaba’s business, nor can Mesaba make any predictions concerning how the various creditor claims and interests of security holders will be determined in the bankruptcy proceedings.

 

Mesaba Operations

Mesaba operates as a regional air carrier providing scheduled passenger service as “Mesaba Airlines/Northwest Airlink” and “Mesaba Airlines/Northwest Jet Airlink” for Northwest.  As discussed above, both Northwest and Mesaba filed for Chapter 11 bankruptcy protection on September 14, 2005 and October 13, 2005, respectively.  Mesaba’s relationship with Northwest is governed by the Airline Services Agreement (the “ASA”) dated August 29, 2005.  Prior to the ASA, Mesaba provided regional airline services to Northwest pursuant to two separate agreements, an Airline Services Agreement (the

 

 

4

 

“Airlink Agreement”) that governed Mesaba’s operation of Saab 340 jet-prop aircraft (“Saabs”), and a Regional Jet Services Agreement (the “Jet Agreement”) that governed Mesaba’s operation of Avro RJ85 regional jets (“Avros”).  The ASA is a ten-year omnibus agreement that incorporates the existing payment terms for the Saabs and Avros contained in the Airlink Agreement and the Jet Agreement, and adds new payment terms for the Canadair regional jets (“CRJs”) that Mesaba began operating in October 2005.  As of March 31, 2006, Mesaba served 102 cities in the United States and Canada from Northwest’s hub airports located in Minneapolis/St. Paul, Detroit and Memphis.

 

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

 

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

 

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

 

For flights utilizing the CRJs, Mesaba recognizes revenue through monthly expense reimbursement payments for actual expenses incurred relating to aircraft rent, maintenance, landing fees and fuel (which is set at a fixed price of $0.70 per gallon for the CRJs); semi-monthly payments for each block hour and cycle operated; a monthly fixed cost payment based on the size of the CRJ fleet (intended to cover Mesaba’s costs that are not reimbursed through the monthly reimbursement payments, which consist mainly of labor costs, ground handling costs, overhead and depreciation) and margin payments based on the revenues described above calculated to achieve a target operating margin.  The target operating margin through April 2007 is set at a fixed amount, after which time the target operating margin will be based on the average operating margin of the publicly traded United States domestic regional airlines operating primarily regional jet aircraft, excluding Pinnacle Airlines Corp. (“Pinnacle”), and any regional carrier under bankruptcy protection, subject to a margin cap and floor.

 

The ASA contains termination provisions that allow both Mesaba and Northwest to terminate the ASA in the event the other party breaches the agreement, subject to the other party’s right to cure the breach within a prescribed time period.  Additionally, Northwest may terminate the ASA in the event of certain lease and other performance defaults by Mesaba; failure by Mesaba to maintain required insurance coverage; failure by Mesaba to allow inspections pursuant to the ASA; change in control events; revocation or failure by Mesaba to obtain Department of Transportation (“DOT”) certification; if Mesaba or its affiliates operate an aircraft type that causes Northwest to be in violation of its collective bargaining agreement with its pilots; failure to elect a chief executive officer/president of Holdings or Mesaba reasonably acceptable to Northwest; if a specified percentage of the aircraft subject to the agreement are not operated for a specified period of time, other than as a result of the Federal Aviation Administration (the “FAA”) grounding all aircraft for all carriers; if there is a strike, cessation or interruption of work

 

 

5

 

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

 

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

 

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

 

The ASA provides for incentive payments from Northwest to Mesaba based on achievement of certain operational goals on a semi-annual basis.  Such incentives totaled $3.7 million, $3.1 million and $4.6 million in fiscal 2006, 2005 and 2004, respectively.

 

Approximately $25.7 million, net of reserve, or 79.2% and $25.9 million, or 88.8%, of Mesaba’s March 31, 2006 and 2005 accounts receivable balances were due from Northwest and were not collateralized.

 

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

 

To date, Northwest has delivered only two CRJ aircraft to Mesaba.  Northwest has advised Mesaba that it will remove one of the CRJs that Mesaba currently operates and place the CRJ with Northwest’s newly formed subsidiary, Compass Airlines, Inc. (“Compass”).  As part of its reorganization, Northwest has also requested bids from regional airlines for the operation of up to 126 CRJ aircraft, 124 of which are currently operated by Pinnacle and two of which are operated by Mesaba.  Mesaba has submitted a proposal to conduct all CRJ flying for Northwest.  If Mesaba is not awarded some or all of the CRJ business, Northwest will remove the other CRJ that Mesaba currently operates.  If Mesaba is awarded additional CRJs by Northwest, it is possible that the terms of the Warrant may be renegotiated to reflect any new arrangement between the parties.

 

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

 

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

 

 

6

 

Finally, in connection with the ASA, and pursuant to its separate agreement with Northwest, Holdings made a capital contribution of approximately $31.7 million to Mesaba in September 2005, just prior to Northwest filing for bankruptcy.

 

Big Sky

Big Sky operates as a regional air carrier based in Billings, Montana, providing scheduled passenger, freight, express package and charter services.  As of March 31, 2006, Big Sky provided scheduled air service to 22 communities in Montana, Colorado, Idaho, Oregon, Washington and Wyoming.  Big Sky operates daily scheduled flights providing interline and online connecting services and local market services.  Big Sky also has code-sharing agreements with Alaska Airlines, Horizon Air, America West Airlines, US Air and Northwest, where its services are marketed jointly with those air carriers for connecting flights.  Big Sky began service to Pocatello, Idaho and Walla Walla, Washington in the fourth quarter of fiscal 2006.

 

Big Sky participates in the Essential Air Service (“EAS”) program with the DOT.  The EAS program subsidizes air carriers to provide air service to designated rural communities throughout the country that could not otherwise economically justify that service based on their passenger traffic.  The DOT pays EAS subsidies for each departure in a covered market.  Big Sky was recently reselected as the EAS provider for seven Montana cities for a two-year period beginning March 1, 2006.

 

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

 

Regulations

 

Pursuant to Federal aviation laws, the DOT and the FAA have certain regulatory authority over the operations of all air carriers.  The jurisdiction of the FAA extends primarily to the safety and operational provisions of the Federal Aviation Act, while the responsibility of the DOT involves principally the regulation of certain economic aspects of airline operations.

 

FAA Regulation

Mesaba and Big Sky each hold an air carrier certificate issued by the FAA permitting Mesaba and Big Sky to conduct flight operations in compliance with Federal Aviation Regulations, which are the same regulatory requirements applicable to major airlines.  The FAA regulations to which Mesaba and Big Sky are subject are extensive and include, among other items, regulation of aircraft maintenance and operations, equipment, ground facilities, dispatch, communications, training, weather observation, flight personnel and other matters affecting air safety.  To ensure compliance with its regulations, the FAA requires airlines to obtain operating, airworthiness and other certificates that are subject to suspension or revocation for cause.  Mesaba and Big Sky hold all certificates necessary for their operations.

 

Under FAA regulations, Mesaba and Big Sky have established, and the FAA has approved, maintenance programs for all aircraft they operate.  These programs provide for the ongoing maintenance of Mesaba’s and Big Sky’s aircraft, ranging from frequent routine inspections to major overhauls.  Mesaba’s and Big Sky’s aircraft require various levels of maintenance or “checks” and periodically undergo complete overhauls.  Maintenance programs are monitored closely by the FAA, with FAA representatives routinely present at the airline’s maintenance facilities.  The FAA issues Airworthiness Directives (“ADs”), which mandate changes to an air carrier’s maintenance program.  These ADs, which include requirements for structural modifications to certain aircraft, are issued to ensure that the nation’s transport aircraft fleet remains airworthy.  Mesaba and Big Sky are currently, and expect to remain, in compliance with all applicable requirements under all ADs and FAA approved maintenance programs.

 

 

7

 

DOT Regulation

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

 

Transportation Security Administration Regulation

In response to the terrorist attacks of September 11, 2001, Congress enacted the Aviation and Transportation Security Act of 2001 (the “ATSA”).  The ATSA created the Transportation Security Administration (the “TSA”) to oversee aviation and airport security.  Among other security measures, the ATSA enhanced background checks, provided for federal air marshals aboard flights, improved flight deck security, enhanced airline crew security training, improved training of security screening personnel and enhanced airport perimeter access.

 

Emergency Wartime Supplemental Appropriations Act

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

 

Railway Labor Act

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

 

Environmental Regulations

Mesaba and Big Sky are subject to regulation under various environmental laws and regulations, including the Clean Air Act, the Clean Water Act and Comprehensive Environmental Response, Compensation and Liability Act of 1980.  In addition, many state and local governments have adopted environmental laws and regulations to which Mesaba’s and Big Sky’s operations are subject.  Environmental laws and regulations are administered by numerous federal and state agencies.  Management of Mesaba and Big Sky believe that they are in compliance with standards for aircraft exhaust emissions and fuel storage facilities issued by the Environmental Protection Agency.

 

Other Regulations

Under the Noise Control Act of 1972 and the Aviation Safety and Noise Abatement Act of 1979, the FAA has authority to monitor and regulate aircraft engine noise.  Management of Mesaba and Big Sky believe that their aircraft comply with or are exempt from such regulations.  As a foreign carrier operating in Canada, Mesaba is subject to regulation by Canada’s Transport Canada department and has been issued a Foreign Air Carrier Operating Certificate and Canadian Transportation Agency economic license.  Because Northwest maintains certain contracts with the Department of Defense, Mesaba is subject to that department’s periodic inspections.

 

 

8

 

Insurance

 

The Company carries the types of insurance customary in the airline industry, including coverage for public liability, passenger liability, property damage, aircraft loss or damage, baggage and cargo liability, war risk, directors’ and officers’ and workers’ compensation.  Mesaba, through the ASA, purchases aviation liability, war risk and hull coverage through a combined placement with Northwest.  The ASA requires that Mesaba maintain specified levels of insurance coverages and also obligates Northwest to use commercially reasonable efforts to allow Mesaba to continue to participate in Northwest’s insurance plan.

 

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

 

Competition

 

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

 

The ASA does not prohibit Northwest from contracting with other regional airlines to provide the same services that Mesaba currently provides.  Northwest currently has an airline services agreement with Pinnacle, and Pinnacle serves many of the same cities as Mesaba.  Northwest could choose to expand its agreement with Pinnacle in competition with Mesaba.  Northwest could also choose to establish relationships with other regional airlines.  Finally, Northwest has formed a new subsidiary, Compass, and Northwest intends to use this subsidiary to operate regional flights.

 

Competitive factors in the airline industry generally include fares, frequency and dependability of service, convenience of flight schedules, type of aircraft flown, airports served, relationships with travel agents, and efficiency and reliability of reservations systems and ticketing services.  The compatibility of flight schedules with those of other airlines and the ability to offer through fares and convenient inter-airline flight connections are also important competitive factors.

 

Fuel

 

The Company believes that the following arrangements assure an adequate supply of fuel for current and future operations for both Mesaba and Big Sky, provided that Northwest does not experience a supply shortage.

 

Mesaba

Mesaba has arrangements with Northwest for its fuel requirements.  Certain provisions of the ASA protect Mesaba from fluctuations in aviation fuel prices for Saab and CRJ flights.  The ASA also requires Northwest to provide fuel for the Avros, at Northwest’s expense, to Mesaba.

 

 

9

 

Big Sky

Big Sky purchases its fuel under arrangements with several fuel suppliers.  None of these arrangements provides protection from fluctuations in fuel prices and supply.

 

Fares

 

Mesaba

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

 

Big Sky

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

 

Aircraft Maintenance

 

The maintenance performed on Mesaba’s and Big Sky’s aircraft can be divided into two general categories:  routine line maintenance and major overhauls.  Line maintenance consists of routine daily and weekly scheduled maintenance checks on aircraft, including pre-flight, daily, weekly and overnight checks and any diagnostic and routine repairs.  Mesaba and Big Sky employ their own aircraft, avionics and engine maintenance staffs that perform substantially all routine line maintenance to the aircraft and engines.  Mesaba contracts out most of its major overhauls on airframes, engines and other rotable parts on the aircraft at FAA authorized facilities.  Major overhauls on Big Sky’s fleets, including airframes, engines and other rotable parts, are performed internally or at FAA authorized facilities.

 

Airport and Terminal Services

 

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

 

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

 

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

 

 

10

 

Employees

 

As of March 31, 2006, Holdings had five employees, and its subsidiaries employed 3,779 employees with approximately 41% of those employees represented by labor unions.  Mesaba had 3,535 (1,128 part-time) employees, and Big Sky had 244 (58 part-time) employees.  Neither Mesaba nor Big Sky had any official work stoppages during fiscal 2006.  The Company’s labor agreements are as follows:

 

Mesaba

 

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

 

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

 

 

11

 

Big Sky

 

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

 

Cyclicality and Seasonality

 

The airline industry generally is subject to cyclical moves in the economy.  Because both personal discretionary travel and business travel may be expected to decline during periods of economic weakness, the airline industry tends to experience poorer financial results during such periods.

 

Mesaba’s cyclicality is tied to the business and operating decisions of Northwest.  Operations of the major airlines continue to be impacted by the rapid growth of low cost airlines, the increasing number of businesses utilizing teleconferencing or web-based meetings and the advent of internet travel web sites, which enable consumers to find travel alternatives.  Mesaba has historically shown greater revenues and earnings in the first and second fiscal quarters.  Northwest has historically seen increased leisure travel during these periods on domestic and international routes, which contributes to an increased number of flights for Mesaba.

 

Seasonal factors, primarily weather conditions and passenger demand, generally affect Big Sky’s monthly passenger boardings.  Big Sky has historically shown a higher level of passenger boardings in the July through December period as compared with the January through June period for many of the cities served.  As a result of such factors, Big Sky’s revenues and earnings have shown a corresponding increase during the July through December period.

 

Recent Developments

 

As discussed more fully in “Item 8. Financial Statements and Supplemental Data, Note 19 — Subsequent Events,” Holdings unconditionally guaranteed Mesaba’s obligations related to Mesaba’s facility at the Cincinnati/Northern Kentucky International Airport.  In accordance with this guaranty, Holdings has been making the required bond and lease payments on the facility since the Petition Date.  On February 15, 2006, Holdings received notice declaring Holdings’ liability for all sums to be immediately due and payable.  On April 18, 2006, Holdings entered into an agreement with UMB Bank, N.A. (“UMB”), the trustee for the bondholders, under which UMB agreed to forbear acceleration of Holdings’ guarantee obligations in exchange for Holdings delivering a letter of credit in the amount of $13.1 million to secure the payment of the obligations guaranteed by Holdings to UMB.

 

 

12

 

Available Information

 

The Company maintains a website at www.mairholdings.com.  On its website, free of charge, the Company makes available its Annual Report on Form 10-K and links to the SEC website for other public filings.  The company’s Code of Ethics for its Chief Executive Officer and financial officers is also available on its website.  All information is also available in print upon written request to the Company’s General Counsel at 150 South Fifth Street, Suite 1360, Minneapolis, Minnesota 55402.  The Company is not including the information contained on or available through its website as a part of, or incorporating such information by reference into, this Annual Report on Form 10-K.

 

Item 1A.  RISK FACTORS

 

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

 

Risks Related to Mesaba’s Bankruptcy

 

Mesaba’s operation during bankruptcy and its emergence from bankruptcy will require interaction with its Creditors’ Committee.

 

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

 

If Mesaba is unable to obtain debtor-in-possession financing, it may be unable to emerge from bankruptcy.

 

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

 

If Mesaba is unable to confirm a reorganization plan, it may be unable to emerge from bankruptcy.

 

In order for Mesaba to emerge from bankruptcy, the Bankruptcy Court must approve a reorganization plan for Mesaba.  The reorganization plan will be subject to a vote by certain classes of creditors, including Mesaba’s secured creditors and unsecured creditors.  The Bankruptcy Court will generally not approve a reorganization plan unless all impaired classes of creditors vote to accept the plan; however, Mesaba may elect to invoke certain provisions of the Bankruptcy Code in order to obtain confirmation of the plan over the vote of a dissenting class of creditors.  In addition to the voting requirements for confirmation, Mesaba will have to satisfy other provisions of the Bankruptcy Code in order to confirm its reorganization plan, including showing that the plan is feasible.  If Mesaba is unable to meet these confirmation requirements, it may be unable to emerge from bankruptcy.

 

 

13

 

If Holdings is unable to find an alternate sublessee for Mesaba’s Cincinnati/Northern Kentucky Airport facility, Holdings may be required to accrue an additional $8.2 million of expense related to the bonds associated with the initial financing of the facility.

 

Mesaba currently leases a facility at the Cincinnati/Northern Kentucky International Airport, but vacated the facility and ceased making the required lease payments on it in November 2005.  Holdings unconditionally guaranteed full and prompt payment of the ground lease and the bonds associated with the initial financing of the facility.  In accordance with this guaranty, Holdings has made the required bond and ground lease payments due since November 2005.  In April 2006, in exchange for the bondholders forbearing acceleration of the bonds, Holdings delivered a letter of credit to the bondholders to assure payment of the bonds.  As of December 31, 2005, Holdings recorded a $4.8 million liability with respect to the lease and guaranty, which assumed that the facility would remain vacant for the next two years, during which time Holdings would continue to make the bond and lease payments, and that thereafter Holdings would be able to sublease the facility at a 20% discount.  If Holdings is unable to find an alternate sublessee for the facility, Holdings may be required to record an additional liability of up to $8.2 million.

 

Any court-approved reorganization by Mesaba could result in Holdings losing all or a portion of its equity in Mesaba.

 

In general, the absolute priority rule in the Bankruptcy Code requires that all of the debtor’s creditors must be paid in full; otherwise the equity holders in the debtor are not entitled to retain their equity interests, unless certain exceptions to the absolute priority rule are met.  It will likely be some time before Mesaba proposes a reorganization plan.  However, the outcome of any vote on Mesaba’s reorganization plan, as well as the terms and conditions of the plan itself, will determine whether Holdings risks losing some or all of its ownership in Mesaba due to the application of the absolute priority rule.

 

Mesaba may need exit financing to emerge from bankruptcy, and there is no assurance Mesaba can obtain exit financing.

 

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

 

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

 

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

 

 

14

 

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

 

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

 

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

 

Certain provisions of the Bankruptcy Code allow a debtor-in-possession to recover transfers of cash or other property that were made prior to the debtor’s bankruptcy filing.  As a result, one of the traditional duties of an official committee of unsecured creditors appointed in a bankruptcy case is to examine transactions between a debtor-in-possession and its affiliates.  In Mesaba’s bankruptcy case, the Creditors’ Committee has requested the right to review various documents concerning transactions between Holdings and Mesaba, including the payment of dividends from Mesaba to Holdings, and to take depositions in order to understand these transactions.  Holdings believes all dividends paid by Mesaba were appropriate and in compliance with the requirements of the Minnesota Business Corporation Act.  However, in order to address any questions about the relationship between Holdings and Mesaba, Holdings has entered into an agreed protective order with the Creditors’ Committee to voluntarily provide documents explaining the relationship between Holdings and Mesaba and to provide witness testimony concerning the documents provided.  The Creditors’ Committee has not completed its review of the transactions between Holdings and Mesaba and, consequently, the Creditors’ Committee has not yet advised Holdings of any specific claims arising from its review.

 

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

 

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

 

 

15

 

Risks Related to Mesaba’s Relationship with Northwest

 

Mesaba is dependent on its relationship with Northwest as its major customer, and the loss of this relationship would substantially harm the Company’s financial results.

 

During fiscal 2006, Northwest accounted for 94.5% of Mesaba’s operating revenues.  Additionally, Mesaba consistently carries a receivable due from Northwest between $12 million to $16 million that is not collateralized.  Due to Northwest’s missed payments prior to and following its bankruptcy filing, Mesaba recorded a reserve of the receivable due from Northwest, net of certain offsetting liabilities, through September 13, 2005, the date of Northwest’s bankruptcy filing.  Mesaba’s future success will depend upon Northwest’s ability to successfully restructure through bankruptcy.  Further, Northwest’s bankruptcy has effectively placed Mesaba’s contracts with Northwest at risk, as Northwest has the option to assume or reject or renegotiate each of such contracts in connection with its bankruptcy proceedings.

 

Mesaba is currently continuing to operate flights for Northwest, but the exact nature of Mesaba’s future relationship with Northwest may not be known until such time as Northwest adopts its bankruptcy reorganization plan.  As of June 8, 2006, Northwest had removed 13 Saabs and 19 Avros from Mesaba’s fleet.  In January 2006, Northwest advised Mesaba that the remaining Avros operated by Mesaba will be removed by the end of December 2006.  Northwest also advised Mesaba that it will remove one of the CRJs that Mesaba currently operates and place the CRJ with Northwest’s newly formed subsidiary, Compass.  Finally, as part of its reorganization, Northwest has requested bids from regional airlines for the operation of up to 126 CRJs, 124 of which are currently operated by Pinnacle, and two of which are currently operated by Mesaba.  If Mesaba is not awarded some or all of the CRJ business, Northwest will remove the remaining CRJ from Mesaba’s fleet.  If Northwest rejects the ASA or negotiates a new ASA (and such renegotiation does not include a waiver by Mesaba of its claims against Northwest), the prepetition amounts owed to Mesaba by Northwest would remain an unsecured claim, and Mesaba would likely receive only a small percentage of the amounts owed to it, and even then would only receive such amounts after a plan of reorganization is approved by Northwest’s bankruptcy court.

 

Northwest has not guaranteed that it will grow Mesaba’s regional fleet, and Northwest could opt to operate new regional aircraft with its own new subsidiary or utilize other regional airlines.

 

The ASA does not prohibit Northwest from contracting with other regional airlines to provide the same services that Mesaba currently provides.  Northwest currently has an airline services agreement with Pinnacle, and Pinnacle serves many of the same cities as Mesaba.  Northwest has issued a request for proposal for the operation of up to 126 CRJs (the total number of CRJs currently operated by Mesaba and Pinnacle combined), and Northwest has also formed a new subsidiary, Compass, that could ultimately operate regional aircraft.  Accordingly, Northwest could choose to expand its agreement with Pinnacle in competition with Mesaba or to contract with other regional airlines or to replace one or both of its current regional airline partners with Compass.

 

Risks Related to the Company’s Business and Operation

 

Mesaba’s and Big Sky’s success is dependent on their ability to obtain all necessary aircraft, engines, parts and related maintenance and support from various aircraft manufacturers and vendors.

 

Mesaba and Big Sky are dependent on various aircraft manufacturers and other vendors to provide sufficient parts and related maintenance and support services on a timely basis.  Additionally, Mesaba and Big Sky rely on various engine manufacturers for parts, repair and overhaul services and other types of support services.  Mesaba’s bankruptcy and nonpayment for prepetition goods and services has adversely affected its relationship with certain vendors.  The failure of aircraft or engine manufacturers and other

 

 

16

 

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

 

Because Mesaba is unable to pass along increased operating costs, Mesaba’s earnings will be negatively affected as its fleet continues to age.

 

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

 

If Mesaba loses certain of its ground handling business, Mesaba’s results of operations could be materially affected.

 

Mesaba performs various ground handling services for Northwest, Pinnacle and other airlines at Minneapolis, Detroit and certain other airport locations.  The ground handling business is highly competitive, and airlines are constantly reviewing their cost structures to locate the most cost-effective ground handling providers.  Mesaba receives the majority of its ground handling revenue from Northwest and Pinnacle, and Mesaba does not have any long-term agreements with either airline.  If Northwest or Pinnacle terminates Mesaba’s ground handling services, Mesaba’s financial results would be materially affected, both through a loss of revenue and increased transition expenses.

 

Mesaba and Big Sky could incur significant costs if they experience difficulty finding, training and retaining employees.

 

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

 

Mesaba and Big Sky could be adversely affected by the highly competitive nature of the airline industry.

 

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

 

 

17

 

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

 

In January 2004, Holdings entered into a letter agreement with ALPA, Mesaba’s pilots’ union, that may limit the types of aircraft Big Sky may fly and may place additional requirements on Holdings if it forms or acquires any other airline subsidiary.  These possible limitations were included in Mesaba’s negotiations with its pilots in Mesaba’s bankruptcy proceedings, and the Bankruptcy Court ruled that Mesaba cannot reject the letter agreement.  In light of this ruling, Holdings is currently assessing its alternatives with respect to the letter agreement.

 

Mesaba’s and Big Sky’s compliance with various regulations governing the airline industry can be costly, and Mesaba and Big Sky could be harmed if they fail to comply with such regulations.

 

Airlines are subject to extensive regulatory and legal requirements that involve significant compliance costs that can result in increased costs for passengers and the airline.  The FAA, DOT and Transportation Security Administration periodically propose additional laws, regulations, taxes and airport rates and charges.  Such measures could have the effect of raising ticket prices, reducing revenue, increasing costs or reducing demand for air travel.  Mesaba and Big Sky expect to continue incurring expenses to comply with existing and future regulations.  Moreover, if either Mesaba or Big Sky fails to comply with applicable regulations, they may be subject to sanctions, including the following:

 

•                  warning letters;

•                  fines;

•                  injunctions;

•                  orders relating to grounding of aircraft, inspection of aircraft, installation of new safety-related items and removal and replacement of certain aircraft parts; or

•                  criminal prosecutions.

 

Future terrorists attacks, other world events, general economic conditions and other factors beyond the Company’s control could substantially harm the Company.

 

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

 

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

 

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

 

 

18

 

Mesaba and Big Sky are increasingly dependent upon technology in their operations, and any failure of such technology could adversely affect them.

 

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

 

Any airline accident in which Mesaba or Big Sky is involved could subject Mesaba or Big Sky to substantial liability and seriously harm the Company’s financial condition and results of operations.

 

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

 

Risks Related to the Company’s Stock

 

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

 

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

 

Future sales of the Company’s common stock by its shareholders could depress the price of the Company’s stock.

 

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

 

 

19

 

2006, the Company had 20,591,840 shares of common stock outstanding.  Several of the Company’s shareholders own substantial blocks of the Company’s common stock.  Additionally, along with the shares of stock it currently owns, Northwest could own an additional large block of the Company’s common stock upon exercise of its Warrant.  In connection with the ASA, the Company entered into a registration rights agreement to register the shares of stock owned by Northwest (including those shares underlying the Warrant).  Prior to entering the ASA, Northwest had pledged certain of these shares to Boeing Capital Corporation (“Boeing”), and Boeing is also a party to the registration rights agreement.  The registration statement has not been filed, and will likely not be filed until a final resolution is reached with respect to the ASA, unless Boeing obtains relief from the automatic stay and is allowed to foreclose on Northwest’s stock pledge and subsequently demand registration.  Nevertheless, following any registration, future sales of those shares, or future sales of other large blocks of the Company’s common stock that are already registered, could substantially depress the Company’s stock price.

 

Any future exercise of the Warrant held by Northwest could substantially dilute the Company’s common stock.

 

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

 

The Company’s stock price may continue to be volatile.

 

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

 

•                  failure of the Company’s operating results to meet analysts’ or investors’ expectations in any quarter;

•                  securities analysts’ estimates;

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

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

•                  increased short sales due to the uncertainty surrounding Mesaba’s bankruptcy, as well as any purchase to cover short positions;

•                  regulatory actions; or

•                  general market conditions.

 

Anti-takeover provisions of the Company’s articles 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 with Minnesota law, could discourage, delay or prevent persons from acquiring or attempting to acquire the Company.  The Company’s articles of incorporation authorize the board of directors, without action by the Company’s shareholders, to designate and issue preferred stock in one or more series, with such rights, preferences and privileges as the board of directors shall determine.  The Company’s articles of incorporation and bylaws also mandate a classified board of directors, which makes changing control of the board more difficult.  The

 

 

20

 

Company’s bylaws grant the board of directors 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 call meetings of the Company’s shareholders.

 

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

 

Item 1B.  UNRESOLVED STAFF COMMENTS

 

None.

 

Item 2.  PROPERTIES

 

Aircraft

 

Mesaba

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

 

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

 

Mesaba leases or subleases its Avro aircraft from Northwest under operating leases with initial terms of up to ten years.  The lease and sublease agreements for the Avros with Northwest contain certain requirements of Mesaba regarding the payment of taxes on the aircraft, acceptable use of the aircraft, the level of insurance to be maintained, the maintenance procedures to be performed and the condition of the aircraft upon their return to Northwest.  The ASA allows Mesaba to return Avros to Northwest upon the occurrence of certain events, including termination of the ASA.

 

Shortly after Northwest filed for bankruptcy, it unilaterally, and in breach of the ASA, removed 12 Avros from Mesaba’s flight schedule.  Mesaba and Northwest then entered into a written agreement under which Northwest acknowledged that Mesaba was not required to make sublease payments on the idled aircraft.  That agreement expired in February 2006.  Mesaba chose to wait to reject the subleases until it was confident that Northwest would not return the idled aircraft to the flight schedule.  Mesaba discontinued recording rent expense of approximately $7.4 million on these Avros through March 31, 2006 when they were idled at the request of Northwest.  In May 2006, Northwest formally rejected its leases for these 12 idled Avros.  To ensure that Northwest’s actions have relieved Mesaba of all liability or obligations arising under the subleases, on June 13, 2006, Mesaba filed a motion with the Bankruptcy Court to seek formal approval of Mesaba’s rejection of the subleases for the 12 idled aircraft.  Mesaba believes that under Section 503(b)(1) of the Bankruptcy Code, which governs administrative claims, Northwest would have no standing to assert an administrative claim against Mesaba for the aircraft rent because Northwest

 

 

21

 

had previously agreed that Mesaba had no obligation to pay rent for grounded aircraft and because Mesaba parked and protected the aircraft at Northwest’s request.

 

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

 

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

 

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

 

Big Sky

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

 

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

 

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

 

Big Sky leases its Metro aircraft from AirLift Inc. and its Beechcraft aircraft from Mesa.  The lease agreements contain certain requirements of Big Sky regarding the payment of taxes on the aircraft, acceptable use of the aircraft, the level of insurance to be maintained, the maintenance procedures to be performed and the condition of the aircraft upon their return.

 

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

 

 

22

 

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

 

Facilities

 

Holdings

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

 

Mesaba

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

 

Mesaba has a ten-year lease agreement for approximately 33,000 square feet of office space for its principal executive offices located in Eagan, Minnesota.  The lease payments of approximately $35,000 per month commenced in January 2004.  The lease expires on December 31, 2013 but contains an early termination provision allowing the lease to be cancelled at the end of seven years.

 

Mesaba subleases approximately 21,000 square feet of office and training support space at the Pan-Am International Flight Academy in Eagan, Minnesota for its flight operations training center.  Mesaba pays approximately $27,000 per month under the terms of this sublease, which has a term of 15 years and expires in January 2017.

 

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

 

Mesaba leases approximately 334,000 square feet of ramp, parking and unimproved land at the Detroit Metropolitan Airport.  The hangar facility of approximately 60,000 square feet located on the property was paid in full in fiscal 2003.  The ground lease has a 20-year term with monthly lease payments of approximately $10,000.  Lease payments are subject to an annual adjustment on January 1 each year based upon the percentage change in an index published by the Bureau of Labor Statistics of the United States Department of Commerce.

 

 

23

 

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

 

Big Sky

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

 

Item 3.  LEGAL PROCEEDINGS

 

Mesaba Bankruptcy

On October 13, 2005, Mesaba filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court for the District of Minnesota.  The Bankruptcy Court is administering Mesaba’s case under the caption “In re Mesaba Aviation, Inc., dba Mesaba Airlines, Case No. 05/39258(GFK).”  Mesaba continues to operate its business and manage its property as a debtor-in-possession pursuant to the Bankruptcy Code.  As a result of the Chapter 11 filing, attempts to collect, secure or enforce remedies with respect to prepetition claims against Mesaba are subject to the automatic stay provisions of Section 362(a) of the Bankruptcy Code, including the Mesaba litigation described below.

 

Saab Leasing Litigation

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

 

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

 

On May 19, 2005, the United States Court of Appeals for the Eighth Circuit (the “Court of Appeals”) affirmed the District Court’s declaratory judgment ruling.  Despite the Court of Appeals’ ruling, Mesaba believes, based on advice from its legal counsel, that it has defenses in the damages case that will limit Saab Leasing’s ability to recover damages.  On September 9, 2005, the District Court heard oral arguments on Saab Leasing’s and Mesaba’s cross-motions for summary judgment.  The District Court did not rule on these motions prior to Mesaba’s bankruptcy petition.

 

On October 14, 2005, Mesaba notified the District Court that Mesaba applied for debtor protection under Chapter 11 of the Bankruptcy Code and that such application operates to automatically stay the

 

 

24

 

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

 

Other Litigation Matters

Mesaba is also a defendant in various lawsuits arising in the ordinary course of business.  While the outcome of these lawsuits and proceedings cannot be predicted with certainty, it is the opinion of Mesaba’s management based on current information and legal advice that the ultimate disposition of these suits will not have a material adverse effect on the separate financial statements of Mesaba.

Item 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

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

 

EXECUTIVE OFFICERS OF THE REGISTRANT

 

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

Robert E. Weil, age 41, has been Vice President, Chief Financial Officer and Treasurer of Holdings since January 2000 and also served as Vice President, Chief Financial Officer of Mesaba from January 2000 to September 2002.  Mr. Weil was the Managing Director of Finance - Ground Operation for Northwest Airlines from December 1997 until joining Holdings.  He also held the position of Controller - Ground Operations and held various other finance positions at Northwest since 1991.  Mr. Weil graduated with a bachelor of arts degree in economics from Northwestern University and a master of management degree from J. L. Kellogg Graduate School of Management.

Ruth M. Timm, age 36, joined the Company in April 2005 as its Vice President, General Counsel.  Ms. Timm was General Counsel at Integris Metals, Inc. from October 2004 until February 2005, when the company was sold to a competitor.  Ms. Timm was an associate in the corporate department of Leonard, Street and Deinard Professional Association from October 2000 until September 2004, and an associate at

 

 

25

 

Maun & Simon, PLC from September 1999 to October 2000.  Ms. Timm served as a judicial law clerk for the Honorable Paul A. Magnuson, Chief Judge, U.S. District Court for the District of Minnesota from 1997 to 1999.  She received her law degree from Valparaiso University School of Law in 1997.

PART II

 

Item 5.  MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS

 

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

 

The following table sets forth, for the periods indicated, the high and low price per share for the Company’s common stock for the two most recent fiscal years.  Quotations for such periods are as reported by Nasdaq for National Market issues.  The Company has not issued cash dividends since September 1995 and does not currently intend to do so in the future.

 

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

 

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

 

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

 

Equity Compensation Plan Information

 

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

 

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

 

 

26

 

Item 6.  SELECTED FINANCIAL DATA

 

The following tables set forth selected financial data with respect to the Company as of the dates and for the periods indicated.  The selected financial data has been derived from the Company’s audited consolidated financial statements, which have been restated to give effect to the restatement discussed in “Item 8. Financial Statements and Supplemental Data, Note 16 — Restatement.”  As of the Petition Date, the accounts of Mesaba were deconsolidated from the Company’s consolidated financial statements.  Therefore, the financial data below excludes Mesaba from the Petition Date forward.  The financial data set forth below should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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

 

 

27

 

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

 

Like other air carriers, Mesaba discloses information regarding passengers, revenue passenger miles, available seat miles, load factor and revenue per available seat mile in “Selected Operating Data” below.  While this data is often used to assess the financial performance of a major carrier, for a regional carrier such as Mesaba operating under a capacity purchase agreement, this data is not directly relevant to Mesaba’s revenues or profitability.  However, it is provided to indicate the size and scope of Mesaba’s operations.

 

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

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

 

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

 

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

 

28

 

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

 

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

 

Item 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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

 

Year in Review and Outlook

 

Summary

Fiscal 2006 is best summarized by reviewing the year in two distinct periods: the time before and the time after the Northwest bankruptcy in September 2005.  Prior to Northwest declaring bankruptcy, Mesaba was focused on adding the CRJ to its certificate and completing the new omnibus ASA with Northwest.  The new ASA extended the Saab and Avro agreements past 2007 to 2015 and provided for 15 new CRJ aircraft.  Mesaba maintained its outstanding operating performance throughout the summer and received FAA certification for the CRJ in less than six months.  In recognition of its strong commitment to safety and loss prevention programs, Mesaba was awarded the AIG Operational Excellence Award during the summer of 2005.  Two CRJs entered Mesaba’s fleet in the first week of September 2005, and Mesaba began operating them in October 2005.  Throughout the summer, Mesaba also implemented a contingency plan to ensure that Northwest’s mechanics’ strike in August 2005 did not impact Mesaba’s operations.

 

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

 

Northwest’s missed payments and its subsequent changes to Mesaba’s fleet adversely affected Mesaba and ultimately resulted in Mesaba filing for bankruptcy protection on October 13, 2005.  Following its bankruptcy filing, Mesaba’s focus moved from adding the CRJ to its fleet to implementing a bankruptcy strategy to reduce its labor and non-labor costs and to emerge as a competitive regional airline that will be able to provide quality regional airline services.

 

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

 

 

29

 

has submitted a bid for additional CRJs, but realizes that many of its competitors have also submitted bids to operate such aircraft.

 

Separately, Big Sky completed its fleet transition, bringing on ten Beechcraft 1900Ds and retiring the Metros. The aftermath of the major hurricanes in the summer and fall of 2005 and the resulting increase in fuel prices negatively impacted Big Sky’s financial results and led to the recording of a $2.5 million goodwill impairment charge.

 

Outlook

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

 

Mesaba

•                  Mesaba will attempt to execute its bankruptcy reorganization strategy, which includes downsizing its fleet to 49 Saabs, achieving significant cost savings, including both labor and non-labor expenses and affirming its business relationship with Northwest by either assuming the existing ASA or negotiating a new ASA.

 

•                  Mesaba will then attempt to develop a plan of reorganization to successfully emerge from bankruptcy as a competitive low-cost supplier of regional flights.

 

Big Sky

•                  Big Sky will focus on growing its Beechcraft 1900D operation by bidding on additional EAS flying and looking for other opportunities to expand its fleet.

 

Holdings

•                  Holdings will explore additional growth opportunities and will consider acquisitions to diversify both within and outside the airline industry.

 

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

 

Earnings Summary

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

 

Mesaba

Mesaba Operating Revenues

Total operating revenues decreased 4.4% in fiscal 2006 to $408.8 million from $427.5 million in fiscal 2005.  The decrease was due primarily to a drop in Avro revenue of $24.9 million or 12.7% as a result of 12 Avros removed from the schedule by Northwest between October 31, 2005 and January 4, 2006.  Avro block hours for fiscal 2006 were down 15.6%.  Saab revenue decreased $0.9 million, or 0.4%, in fiscal 2006 compared to fiscal 2005 primarily due to a decrease in Saab ASMs of 2.8% and an increase in the fuel offset to revenue year over year.  The decline in Saab revenue was partially offset by an increase in rate per ASM of 4.1% and an increase in the passenger stipend due to an increased number of passengers flying the Saab aircraft.  The decrease in Saab and Avro revenue was offset in part by the additional

 

 

30

 

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

 

Mesaba Operating Expenses

Total operating expenses in fiscal 2006 increased 8.7% to $448.9 million from $413.1 million in fiscal 2005.  The cost per ASM increased 20.7% to $0.163 in fiscal 2006 from $0.135 in fiscal 2005.  The following table compares components of operating cost per ASM for the years ended March 31:

 

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