MESA AIR GROUP INC - Quarter Report: 2006 March (Form 10-Q)

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Commission File Number 0-15495

Mesa Air Group, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(602) 685-4000

      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 last 90 days.     Yes þ          No 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 þ          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 þ

      On May 3, 2006, the registrant had outstanding 36,144,455 shares of Common Stock.

TABLE OF CONTENTS

INDEX

PART 1. FINANCIAL INFORMATION

MESA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

See accompanying notes to condensed consolidated financial statements.

MESA AIR GROUP, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to condensed consolidated financial statements.

MESA AIR GROUP, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes to condensed consolidated financial statements.

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

      The accompanying unaudited, condensed consolidated financial statements of Mesa Air Group, Inc. (“Mesa” or the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for a complete set of financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the results for the periods presented have been made. Operating results for the three and six-month periods ended March 31, 2006, are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2006. These condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the fiscal year ended September 30, 2005.

      The accompanying condensed consolidated financial statements include the accounts of Mesa Air Group, Inc. and its wholly-owned operating subsidiaries: Mesa Airlines, Inc. (“Mesa Airlines”), a Nevada corporation and certificated air carrier; Freedom Airlines, Inc. (“Freedom”), a Nevada corporation and certificated air carrier; Air Midwest, Inc. (“Air Midwest”), a Kansas corporation and certificated air carrier; MPD, Inc. (“MPD”), a Nevada corporation, doing business as Mesa Pilot Development; Regional Aircraft Services, Inc. (“RAS”) a Pennsylvania corporation; Mesa Leasing, Inc., a Nevada corporation; Mesa Air Group — Airline Inventory Management, LLC (“MAG-AIM”), an Arizona Limited Liability Company; Ritz Hotel Management Corp., a Nevada Corporation; and MAGI Insurance, Ltd. (“MAGI”), a Barbados, West Indies based captive insurance company. MPD, Inc. provides pilot training in coordination with a community college in Farmington, New Mexico and with Arizona State University in Tempe, Arizona. RAS performs aircraft component repair and overhaul services and ground handling services. MAGI is a captive insurance company established for the purpose of obtaining more favorable aircraft liability insurance rates. All significant intercompany accounts and transactions have been eliminated in consolidation. In addition, the Company has announced that Mesa Airlines will begin providing inter-island service in Hawaii as go! beginning in the third quarter of fiscal 2006. This operation is referred to herein as “go!”.

      Statement of Financial Accounting Standard (“SFAS”) No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires disclosures related to components of a company for which separate financial information is available that is evaluated regularly by a company’s chief operating decision maker in deciding the allocation of resources and assessing performance. The Company has three airline operating subsidiaries, Mesa Airlines, Freedom Airlines and Air Midwest, as well as various other subsidiaries organized to provide support for the Company’s airline operations. In addition, Mesa Airlines plans to begin providing inter-island service in Hawaii as go! beginning in the third quarter of fiscal 2006. The Company has aggregated these subsidiaries into three reportable segments: Mesa Airlines/ Freedom, Air Midwest/go! and Other. Mesa Airlines and Freedom Airlines operate regional jets and Dash-8 aircraft pursuant to revenue guarantee contracts. Air Midwest operates the Company’s Beech 1900 turboprop aircraft and go! will operate regional jets, whereby the Company assumes revenue risk. The Other reportable segment includes Mesa Air Group (the holding company), RAS, MPD, MAG-AIM, MAGI, Mesa Leasing, Inc. and Ritz Hotel Management Corp., all of which support Mesa’s operating subsidiaries. In October 2004, the Company transitioned certain of its regional jets from Freedom into Mesa and transferred a B1900D aircraft from Air Midwest into Freedom. As a result, Freedom was grouped with Air Midwest in fiscal 2005 for segment purposes. In fiscal 2006, Freedom began operating under a revenue-guarantee code-share agreement with Delta utilizing ERJ145 aircraft that were transitioned from Mesa Airlines. As such, the Company has aggregated Freedom with Mesa Airlines beginning in the first quarter of fiscal 2006. Operating revenues in the

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Other segment are primarily sales of rotable and expendable parts to the Company’s operating subsidiaries and ground handling services performed by employees of RAS for Mesa Airlines.

      Mesa Airlines and Freedom Airlines provide passenger service with regional jets under revenue-guarantee contracts with United Airlines, Inc. (“United”), Delta Air Lines, Inc. (“Delta”) and America West Airlines, Inc. (“America West”), which currently operates as US Airways and is referred to herein as “US Airways.” The current US Airways is a result of a merger between America West and US Airways, Inc. (“Pre-Merger US Airways”). Mesa Airlines also provides passenger service with Dash-8 aircraft under revenue-guarantee contracts with US Airways and United. As of March 31, 2006, Mesa Airlines and Freedom Airlines operated a fleet of 160 aircraft — 108 CRJs, 36 ERJs and 16 Dash-8s. Prior to operating ERJ 145 aircraft, Freedom most recently operated Beechcraft 1900D under a pro-rate agreement with US Airways.

      Air Midwest provides passenger service with Beechcraft 1900D aircraft under pro-rate contracts with US Airways and Midwest Airlines, Inc. (“Midwest Airlines”) as well as independent operations as Mesa Airlines. As of March 31, 2006, Air Midwest operated a fleet of 20 Beechcraft 1900D turboprop aircraft.

      The Other category consists of Mesa Air Group, RAS, MPD, MAG-AIM, MAGI, Mesa Leasing, Inc. and Ritz Hotel Management Corp. Mesa Air Group performs all administrative functions not directly attributable to any specific operating company. These administrative costs are allocated to the operating companies based upon specific criteria including headcount, available seat miles (“ASM’s”) and other operating statistics. MPD operates pilot training programs in conjunction with San Juan College in Farmington, New Mexico and Arizona State University in Tempe, Arizona. Graduates of these training programs are eligible to be hired by the Company’s operating subsidiaries. RAS primarily supplies repair services and ground handling services to the Company’s operating subsidiaries. MAGI is a captive insurance company located in Barbados. MAG-AIM is the Company’s inventory procurement and sales company.

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company has a cash management program which provides for the investment of excess cash balances primarily in short-term money market instruments, US treasury securities, intermediate-term debt instruments, and common equity securities of companies operating in the airline industry.

      SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” requires that all applicable investments be classified as trading securities, available for sale securities or held-to-maturity securities. The Company currently has $167.5 million in marketable securities that include US Treasury notes, government bonds, corporate bonds and auction rate securities (“ARS”). These investments are classified as trading securities during the periods presented and accordingly, are carried at market value with changes in value reflected in the current period operations. Unrealized losses relating to trading securities held at March 31, 2006 and September 30, 2005, were $0.9 million and $0.5 million, respectively.

      The Company has determined that investments in auction rate securities should be classified as short-term investments. ARS generally have long-term maturities; however, these investments have characteristics similar to short-term investments because at predetermined intervals, generally every 28 days, there is a new auction process. As such, the Company classifies ARS as short-term investments. The balance of marketable securities at March 31, 2006 and September 30, 2005 includes investments in ARS of $47.7 million and $46.7 million, respectively.

      At March 31, 2006, the Company had $11.7 million in restricted cash on deposit with two financial institutions. In September 2004, the Company entered into an agreement with a financial institution for a $9.0 million letter of credit facility and to issue letters of credit for landing fees, workers compensation insurance and other business needs. Pursuant to the agreement, $6.7 million of outstanding letters of credit at March 31, 2006 are collateralized by amounts on deposit. The Company also maintains $5.0 million on deposit with another financial institution to collateralize its direct deposit payroll obligations.

      The Company has code-share agreements with US Airways, Pre-Merger US Airways, United, Delta and Midwest Airlines. Approximately 99% of the Company’s consolidated passenger revenue for the three months ended March 31, 2006 was derived from these agreements. Accounts receivable from the Company’s code-share partners were 44% and 35% of total gross accounts receivable at March 31, 2006 and September 30, 2005, respectively.

      Pre-Merger US Airways filed for Chapter 11 bankruptcy protection on September 12, 2004. As of March 31, 2006, Mesa operated 8 50-seat regional jet aircraft for US Airways under a revenue-guarantee code-sharing agreement. As a result of US Airways’ emergence from bankruptcy in September 2005 and their non-assumption of the Company’s revenue-guarantee code-share agreement, the Company expanded its regional jet revenue-guarantee code-share agreement with United and entered into a new revenue-guarantee code-share agreement with Delta. The Company is currently working to transition the jets flown under the Pre-Merger US Airways code-share agreement to United and Delta. As of May 8, 2006, the Company had transitioned 54 of the 59 aircraft. The Company expects to complete the transition of aircraft from US Airways during the third quarter of fiscal year 2006. In addition, on September 14, 2005, Delta Air Lines filed for reorganization under Chapter 11 of the US Bankruptcy Code. Delta has not yet assumed the code-share agreement with the Company in its bankruptcy proceeding and could choose to terminate our regional jet agreement or seek to renegotiate the agreement on less favorable terms.

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In May 2005, the Company amended its code-sharing arrangement with United to allow the Company to put up to an additional 30 50-seat regional jet aircraft into the United Express system. The agreement with respect to the additional 30 50-seat regional jet aircraft expires in April 2010. Additionally, the expiration dates under the existing code-share agreement with respect to certain aircraft were extended. The code-share agreement for (i) the ten Dash-8 aircraft terminates in July 2013, and United Airlines’ right to terminate earlier will not begin until April 2010, (ii) the 15 50-seat CRJ-200s currently terminates in April 2010, (iii) the 15 70-seat regional jets (to be delivered upon the withdrawal of the 50-seat regional jets) terminates on the earlier of ten years from delivery date or October 2018 and (iv) the remaining 15 70-seat regional jets terminates in three tranches between December 2011 and December 2013. In connection with the amendment, the Company made three $10 million payments to United as follows: i) $10 million in June 2005, ii) $10 million in October 2005, and iii) $10 million in November 2005. Amounts paid are recorded as a deferred charge and included in other assets on the balance sheet. The deferred charge is being amortized over the term of the code-share agreement as a reduction of passenger revenue. Amortization of $0.7 million and $1.5 million was recorded for the three and six-month periods ended March 31, 2006, respectively.

      In August 2005, the Company entered into a ten-year agreement with AAR Corp. (the “AAR Agreement”), for the management and repair of certain of the Company’s CRJ-200, -700, -900 and ERJ-145 aircraft rotable spare parts inventory. Under the agreement, the Company sold certain existing spare parts inventory to AAR for $39.5 million in cash and $21.5 million in notes receivable to be paid over four years. The AAR agreement was contingent upon the Company terminating an agreement for the Company’s CRJ-200 aircraft rotable spare parts inventory with GE Capital Aviation Services (“GECAS”) and including these rotables in the arrangement. The Company terminated the GECAS agreement and finalized the AAR agreement in November 2005. Upon entering into the agreement, the Company received $22.8 million, which was recorded as a deposit at September 30, 2005, pending the termination of the GECAS agreement. Under the agreement, the Company is required to pay AAR a monthly fee based upon flight hours for access to and maintenance of the inventory. The agreement also contains certain minimum monthly payments that Mesa must make to AAR. Based on this arrangement, the Company accounts for the transaction as an operating lease of rotable equipment with AAR. At termination, the Company may elect to purchase the covered inventory at fair value, but is not contractually obligated to do so.

      Deferred credits consist of aircraft purchase incentives provided by the aircraft manufacturers and deferred gains on the sale and leaseback of interim financed aircraft. These incentives include credits that may be used to purchase spare parts, pay for training expenses or reduce other aircraft operating costs. These deferred credits and gains are amortized on a straight-line basis as a reduction of lease expense over the term of the respective leases.

      The Company had three aircraft on interim financing with the manufacturer at March 31, 2006. Under interim financing arrangements, the Company takes delivery and title to the aircraft prior to securing permanent financing and the acquisition of the aircraft is accounted for as a purchase with debt financing. Accordingly, the Company reflects the aircraft and debt under interim financing on its balance sheet during the interim financing period. After taking delivery of the aircraft, it is the Company’s intention to permanently finance the aircraft as an operating lease through a sale and leaseback transaction with an independent third-

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

party lessor. Upon permanent financing, the proceeds are used to retire the notes payable to the manufacturer. Any gain recognized on the sale and leaseback transaction is deferred and amortized over the life of the lease.

      At March 31, 2006 and September 30, 2005, the Company had $82.1 million and $54.6 million, respectively, in notes payable to an aircraft manufacturer for aircraft on interim financing. These interim financings agreements typically have an initial term of six months and provide for monthly interest only payments at LIBOR plus three percent. The current interim financing agreement with the manufacturer allows for the Company to have a maximum of 15 aircraft on interim financing at a given time. The Company is currently in negotiations to extend the interim financing agreements that expired in the second quarter of fiscal 2006.

      Long-term debt consisted of the following:

      During the quarter ended March 31, 2006, holders of $144.8 million in aggregate principal amount at maturity ($57.5 million carrying amount) of the Company’s Senior Convertible Notes due 2023 (the “Notes”) converted Notes into shares of Mesa common stock. In connection with the conversions during the quarter ended March 31, 2006, the Company issued an aggregate of 5,751,121 shares of Mesa common stock and paid approximately $10.5 million to these Noteholders. Amounts paid to Noteholders were recorded as Other Expense in the Consolidated Statement of Income for the quarter ended March 31, 2006. Under the terms of the Notes, each $1,000 of aggregate principal amount at maturity of Notes is convertible into 39.727 shares of Mesa common stock at the option of the Noteholders under certain circumstances. The shares of common stock issuable upon conversion of the Notes have previously been included in the calculation of diluted earnings per share. Consequently, issuance of the shares will not be further dilutive to reported diluted earnings per share.

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company accounts for earnings per share in accordance with SFAS No. 128, “Earnings per Share.” Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the periods presented. Diluted net income per share reflects the potential dilution that could occur if outstanding stock options and warrants were exercised. In addition, dilutive convertible securities are included in the denominator while interest on convertible debt, net of tax, is added back to the numerator. A reconciliation of the numerator and denominator used in computing net income per share is as follows:

      Options to purchase 183,200 and 2,248,406 shares of common stock were outstanding during the quarters ended March 31, 2006 and 2005, respectively, but were excluded from the calculation of dilutive earnings per share because the options’ exercise prices were greater than the average market price of the common shares and, therefore, the effect would have been antidilutive.

      The Company’s Board of Directors has authorized the Company to purchase up to 19.4 million shares of the Company’s outstanding common stock, including 10 million shares authorized in November 2005. As of March 31, 2006, the Company has acquired and retired approximately 8.1 million shares of its outstanding common stock at an aggregate cost of approximately $48.0 million, leaving approximately 11.3 million shares available for purchase under existing Board authorizations. Purchases are made at management’s discretion based on market conditions and the Company’s financial resources.

      The Company did not repurchase any shares during the three months ended March 31, 2006.

      On February 7, 2002, the Company entered into an agreement with Raytheon Aircraft Credit Company (the “Raytheon Agreement”) to reduce the operating costs of its Beechcraft 1900D fleet. In connection with the Raytheon Agreement and subject to the terms and conditions contained therein, Raytheon agreed to provide up to $5.5 million in annual operating subsidy payments to the Company contingent upon satisfying certain spending requirements and, among other things, the Company remaining current on its payment obligations to Raytheon. The amount was subsequently reduced to $5.2 million as a result of reductions in the

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Company’s fleet of B1900D aircraft. Approximately $1.3 million was recorded as a reduction to expense during the three months ended March 31, 2006 and 2005. Approximately $2.6 million and $2.7 million was recorded as a reduction to expense during the six months ended March 31, 2006 and 2005, respectively.

      In return, the Company granted Raytheon an option to purchase up to 233,068 warrants at a purchase price of $1.50 per warrant. Each warrant entitles the holder to purchase one share of common stock at an exercise price of $10.00 per share. At March 31, 2006, Raytheon was vested in and exercised its option to purchase all 233,068 warrants.

      Included in interest expense on the statements of income was interest expense related to aircraft financing of $7.1 million and $6.8 million for the three months ended March 31, 2006 and 2005, respectively, and $14.0 million and $12.7 million for the six months ended March 31, 2006 and 2005, respectively.

      The changes in the impairment and restructuring charges for the periods ended March 31, 2006 and 2005 are as follows:

      The Company has stock option plans. Prior to October 1, 2005, the Company accounted for these plans under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based Compensation.” Effective October 1, 2005, the Company adopted the fair value recognition provisions of SFAS No. 123(R), “Share-Based Payments,” using the modified prospective transition method: option awards granted, modified, or settled after the date of adoption are required to be measured and accounted for in accordance with SFAS 123(R). Unvested equity-classified awards that were granted prior to the effective date will continue to be accounted for in accordance with SFAS 123, and compensation amounts for awards that vest will now be recognized in the income statement as an expense.

      Stock-based compensation cost recognized in the quarter ended March 31, 2006 includes: (a) compensation cost for all share-based payments granted prior to October 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to September 30, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R).

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company estimates the fair value of stock awards issued using the Black-Scholes option pricing model. Expected volatilities are based on the historical volatility of the Company’s stock and other factors. The Company uses historical data to estimate option exercises and employee terminations within the valuation model. The expected term of options granted is derived from historical exercise experience and represents the period of time the Company expects options granted to be outstanding. The risk-free rates for the periods within the contractual life of the option are based on the U.S. Treasury yield curve in effect at the time of the grant. Option valuation models require the input of subjective assumptions including the expected volatility and lives. Actual values of grants could vary significantly from the results of the calculations. There were no options granted during the second quarter of fiscal 2006. The weighted average fair value of options granted during the six months ended March 31, 2006 was $6.44. The following assumptions were used to value stock option grants during the following period:

      Compensation cost for options granted prior to October 1, 2005 was recognized on an accelerated amortization method over the vesting period of the options. Compensation cost for options granted after September 30, 2005 was recognized on a straight-line basis over the vesting period. The following amounts were recognized for stock-based compensation (in thousands):

      As of March 31, 2006, there was $1.8 million of total unrecognized compensation cost related to stock options. This cost is expected to be recognized over a weighted average period of 0.9 years.

      Prior to the adoption of SFAS No. 123(R), the Company presented all tax benefits resulting from the exercise of stock options as operating cash flows in the condensed consolidated statement of cash flows. SFAS No. 123(R) requires cash flows resulting from excess tax benefits to be classified as financing cash flows. Excess tax benefits result from tax deductions in excess of the compensation cost recognized for those options.

      Under the provisions of SFAS No. 123(R), the recognition of deferred compensation, a contra-equity account representing the amount of unrecognized restricted stock expense is no longer required. Therefore, at October 1, 2005, “Unearned compensation on restricted stock” was combined with “Common stock of no par value and additional paid-in capital” in the Company’s condensed consolidated balance sheet.

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The Company applied the provision of APB Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans prior to October 1, 2005. Accordingly, no compensation cost was recognized for awards made pursuant to its stock option plans. Had the compensation cost for the Company’s stock-based compensation plans been determined consistent with the measurement provision of SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” the Company’s net income and net income per share would have been as indicated by the pro forma amounts indicated below:

      A summary of award activity under the stock option plans as of March 31, 2006 and changes during the three month period are summarized as follows:

      The Company has 1,852,000 fully vested options outstanding as of March 31, 2006, which have a weighted average exercise price of $7.25, an aggregate intrinsic value of $8.0 million and a weighted average remaining contractual term of 4.6 years. The total intrinsic value of options exercised during the quarters ended March 31, 2006 and 2005 was $3.1 million and less than $0.1 million, respectively. The total intrinsic value of options exercised during the six-month periods ended March 31, 2006 and 2005 was $3.6 million and $0.2 million, respectively.

MESA AIR GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      A summary of the activity for nonvested share awards as of March 31, 2006 and changes during the three month period are summarized as follows:

      In May 2001, the Company entered into an agreement with Bombardier Regional Aircraft Division (“BRAD”) under which the Company has an option to acquire 80 CRJ-700 and CRJ-900 regional jets. In January 2004, the Company converted options on 20 CRJ-900 aircraft to firm orders (seven of which can be converted to CRJ-700s). As of March 31, 2006, the Company has taken delivery of 13 CRJ-900 aircraft under the converted options. In conjunction with this purchase agreement, Mesa had $16.0 million on deposit with BRAD that was included in lease and equipment deposits at March 31, 2006. The BRAD deposits are expected to be returned upon completion of permanent financing on each of the last five aircraft on order ($3.0 million per aircraft) and $1.0 million at the Company’s option.

      In February 2006, Hawaiian Airlines, Inc. (“Hawaiian”) filed a complaint against the Company in the United States Bankruptcy Court for the District of Hawaii alleging that Mesa breached the terms of a Confidentiality Agreement entered into in February 2004 with the Trustee in Hawaiian’s bankruptcy proceedings. The complaint alleges, among other things, that Mesa breached the Confidentiality Agreement by (a) using the evaluation material to obtain a competitive advantage over Hawaiian, through the development and implementation of a business plan to compete with Hawaiian in the inter-island market, and (b) failing to return or destroy any evaluation materials after being notified by Hawaiian on or about May 12, 2004 that Mesa had not been selected as a potential investor for a transaction with Hawaiian. Hawaiian, in its complaint, seeks unspecified damages, an injunction requiring Mesa to turn over to Hawaiian any evaluation material in Mesa’s possession, custody or control, and an injunction preventing Mesa from providing inter-island transportation services in the State of Hawaii for a period of two years from the date of such injunctive relief.

      Mesa vigorously denies Hawaiian’s allegations and requests for relief contained in its complaint. In addition to filing pleadings to move Hawaiian’s lawsuit from the United States Bankruptcy Court for the District of Hawaii to the United States District Court for the District of Hawaii, Mesa has filed a counterclaim against Hawaiian alleging that Hawaiian’s lawsuit against Mesa is itself an anticompetitive act designed to prevent Mesa from entering the Hawaiian inter-island market, in violation of the Sherman Anti-trust Act. Mesa’s counterclaim alleges that Hawaiian has intentionally interfered with Mesa’s prospective economic advantage and has committed unfair trade practices. While the Company believes resolution of this matter will not have a material adverse impact on its financial condition or results of operations, the litigation and claims noted above are subject to inherent uncertainties and the Company’s view of such matters may change in the future.

      The Company is involved in various other legal proceedings and FAA civil action proceedings that the Company does not believe will have a material adverse effect upon the Company’s business, financial condition or results of operations, although no assurance can be given to the ultimate outcome of any such proceedings.

Item 1.A.  Risk Factors.

      In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part 1, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended September 30, 2005, and Part  I, Item 1A. “Risk Factors” in our Quarterly Report on Form 10-Q for the quarter ended December 31, 2005, which could materially affect our business, financial condition or future results. We caution the reader that these risk factors may not be exhaustive. We operate in a continually changing business environment and new risk factors emerge from time to time. Management cannot predict such new risk factors, nor can we assess the impact, if any, of such new risk factors, nor can we assess the impact, if any, of such new risk factors on our business or to the extent to which any factor or combination of factors may impact our business. As a result of litigation relating to our Hawaiian operations, we may face additional risk factors, including the one identified below. All of these factors, in addition to the information discussed elsewhere herein, should be carefully considered in evaluating us and our business:

      We are, from time to time, subject to various legal proceedings and claims, either asserted or unasserted. Any such claims, whether with or without merit, could be time-consuming and expensive to defend and could divert management’s attention and resources. There can be no assurance regarding the outcome of current or future litigation.

      On or about February 13, 2006, Hawaiian Airlines, Inc. (“Hawaiian”) filed a complaint against us in the United States Bankruptcy Court for the District of Hawaii alleging that we breached the terms of a Confidentiality Agreement entered into in February 2004 with the Trustee in Hawaiian’s bankruptcy proceedings. The complaint alleges, among other things, that we breached the Confidentiality Agreement. Hawaiian, in its complaint, seeks unspecified damages, an injunction requiring Mesa to turn over to Hawaiian any evaluation material in Mesa’s possession, custody or control, and an injunction preventing Mesa from providing inter-island transportation services in the State of Hawaii for a period of two years from the date of such injunctive relief.

      Mesa vigorously denies Hawaiian’s allegations and requests for relief contained in its complaint. In addition to filing pleadings to move Hawaiian’s lawsuit from the United States Bankruptcy Court for the District of Hawaii to the United States District Court for the District of Hawaii, Mesa has filed a counterclaim against Hawaiian alleging that Hawaiian’s lawsuit against Mesa is itself an anticompetitive act designed to prevent mesa from entering the Hawaiian inter-island market, in violation of the Sherman Anti-Trust Act. Mesa’s counterclaim alleges that Hawaiian has intentionally interfered with Mesa’s prospective economic advantage and has committed unfair trade practices. While we believe resolution of this matter will not have a material adverse impact on our financial condition or results of operations, the litigation and claims noted above are subject to inherent uncertainties and our view of such matters may change in the future.

      If, as a result of this litigation, we are unable to successfully launch or profitably operate our planned Hawaiian airline services, out business and operations could be negatively impacted.

      We have announced plans to commence an independent inter-island Hawaiian airline operation named go! with service expected to begin June 9, 2006. Launching service in Hawaii will require ongoing investment of working capital by Mesa, significant management attention and focus, regulatory approval by state and federal regulators, location of suitable facilities and may involve a partnership or venture with financial investors.

      We have not had operations in Hawaii prior to this planned launch and we may be unable to begin service when planned. If we are unable to begin service when planned or are unable to begin service at all, our operations may be negatively impacted. Additionally, given the costs and risks associated with operating an

independent low fare regional jet airline, once service begins we may be unable to operate the Hawaiian airline profitably, which would negatively impact our business, financial condition and results of operations.

      In addition, our results under our revenue-guarantee contracts offer no meaningful guidance with respect to our future performance running an independent airline because we have not previously operated as an independent regional jet carrier in Hawaii. We will be operating under a new brand that will initially have limited market recognition. Future performance will depend on a number of factors, including our ability to:

      The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the Company’s results of operations and financial condition. The discussion should be read in conjunction with the Consolidated Financial Statements and the related notes thereto, and the Selected Financial Data and Operating Data contained elsewhere herein.

Forward-Looking Statements

      This Quarterly Report on Form 10-Q contains certain statements including, but not limited to, information regarding the replacement, deployment, and acquisition of certain numbers and types of aircraft, and projected expenses associated therewith; costs of compliance with Federal Aviation Administration regulations and other rules and acts of Congress; the passing of taxes, fuel costs, inflation, and various expenses to the consumer; the relocation of certain operations of Mesa; the resolution of litigation in a favorable manner and certain projected financial obligations. These statements, in addition to statements made in conjunction with the words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” and similar expressions, are forward-looking statements within the meaning of the Safe Harbor provision of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These statements relate to future events or the future financial performance of Mesa and only reflect management’s expectations and estimates. The following is a list of factors, among others, that could cause actual results to differ materially from the forward-looking statements: changing business conditions in certain market segments and industries; changes in Mesa’s code-sharing relationships; the inability of US Airways, Delta Air Lines or United Airlines to pay their obligations under the code-share agreements; the ability of Delta Air Lines to reject our code-share agreements in bankruptcy; the inability to transition the planes we currently fly under our code-share agreement with Pre-Merger US Airways without undue cost and expense; an increase in competition along the routes Mesa operates or plans to operate; difficulties or delays in connection with launching our new Hawaiian operations; material delays in completion by the manufacturer of the ordered and yet-to-be delivered aircraft; availability and cost of funds for financing new aircraft; changes in general economic conditions; changes in fuel prices; changes in regional economic conditions; changes in Mesa’s relationship with employees and the terms of future collective bargaining agreements; the impact of current and future laws; additional terrorist attacks; Congressional investigations, and governmental regulations affecting the airline industry and Mesa’s operations; bureaucratic delays; amendments to existing legislation; consumers unwilling to incur greater costs for flights; unfavorable resolution of negotiations with municipalities for the leasing of facilities; and risks associated with the outcome of litigation. One or more of these or other factors may cause Mesa’s

actual results to differ materially from any forward-looking statement. Mesa is not undertaking any obligation to update any forward-looking statements contained in this Form 10-Q.

      All references to “we,” “our,” “us,” or “Mesa” refer to Mesa Air Group, Inc. and its predecessors, direct and indirect subsidiaries and affiliates.

      Investors should read the risks identified under “Item 1.A. — Risk Factors” above for a more detailed discussion of these and other factors.

GENERAL

      Mesa is a holding company whose principle subsidiaries operate as regional air carriers providing scheduled passenger and airfreight service. As of March 31, 2006, we served 172 cities in 45 states, the District of Columbia, Canada and Mexico and operated a fleet of 180 aircraft with approximately 1,050 daily departures.

      Approximately 99% of our consolidated passenger revenues for the quarter ended March 31, 2006 were derived from operations associated with code-share agreements. Our subsidiaries have code-share agreements with United Airlines, Delta Air Lines and Midwest Airlines, America West Airlines, Inc. (“America West,” which currently operates as US Airways and is referred to herein as “US Airways”). The current US Airways is the result of a merger between America West and US Airways, Inc. (“Pre-Merger US Airways”). Our remaining passenger revenues are derived from our independent operations.

      In the second quarter of fiscal 2006, approximately 97% of our passenger revenue was associated with revenue-guarantee flying. The US Airways (regional jet and Dash-8), Pre-Merger US Airways (regional jet), United (regional jet and Dash-8), and Delta (regional jet) code-share agreements are revenue-guarantee flying agreements. Under the terms of these flying agreements, the major carrier controls marketing, scheduling, ticketing, pricing and seat inventories. Our role is simply to operate our fleet in the safest and most reliable manner in exchange for fees paid under a generally fixed payment schedule. We receive a guaranteed payment based upon a fixed minimum monthly amount plus amounts related to departures and block hours flown in addition to direct reimbursement of expenses such as fuel, landing fees and insurance. We are also eligible to receive additional compensation based upon our performance under certain of our revenue-guarantee contracts. Among other advantages, revenue-guarantee arrangements reduce our exposure to fluctuations in passenger traffic and fare levels, as well as fuel prices. In the second quarter of fiscal 2006, approximately 97% of our fuel purchases were reimbursed under revenue guarantee code-share agreements.

      In the second quarter of fiscal 2006, approximately 3% of our passenger revenue was associated with pro-rate and independent flying. The US Airways (Beechcraft 1900D turboprop) and Midwest Airlines code-share agreements are pro-rate agreements, for which we received an allocated portion of each passenger’s fare and we pay all of the costs of transporting the passenger.

      In addition to carrying passengers, we carry freight and express packages on our passenger flights and have interline small cargo freight agreements with many other carriers. We also have contracts with the U.S. Postal Service for carriage of mail to the cities we serve and occasionally operate charter flights when our aircraft are not otherwise used for scheduled service.

      In March 2006, we announced an expansion of flying for Delta Air Lines. Under this new agreement Freedom Airlines, a wholly owned subsidiary of Mesa Air Group, will fly twelve, 37-seat, De Havilland Dash 8 aircraft in support of Delta’s expanding operations at its New York-JFK hub. The term of the new agreement is three years. The aircraft will be operated under a capacity purchase arrangement similar to Mesa’s existing Delta Connection agreement under which Freedom Airlines flies 50-seat

regional jets. The Dash 8s covered under this agreement will be incremental to the 16 Dash 8 aircraft currently operated by Mesa Air Group.

      In addition, we have announced that Mesa Airlines plans to begin providing inter-island service in Hawaii as go! beginning in the third quarter of fiscal 2006. Service will initially be provided with five CRJ-200 aircraft. These aircraft are incremental to our current fleet.

      Also in the second quarter of fiscal 2006, we returned one CRJ-100 aircraft to the lessor, decreasing our regional jet fleet to 144 regional jets at March 31, 2006.

      Freedom commenced operations with Delta in October 2005 and is contracted to operate 30 50-seat regional jet aircraft on routes throughout Delta’s network. However, Delta has not yet assumed our code-share agreement in its bankruptcy proceedings and could choose to terminate our agreement at any time prior to its emergence from bankruptcy. The Company currently operates 20 ERJ-145 regional aircraft in revenue service for Delta.

      In May 2005, we amended our code-sharing arrangement with United to allow us to put up to an additional 30 50-seat regional jet aircraft into the United Express system and extend the expiration dates under the existing code-share agreement with respect to certain aircraft. In connection with the amendment, we made $20 million in payments to United in the first quarter of fiscal 2006. We currently operate 70 aircraft in revenue service for United.

      As of March 31, 2006, we had transitioned 51 of the 59 (54 of the 59 as of May 8, 2006) 50-seat regional jets out of Pre-Merger US Airways operations and into operations with Delta and United. We are currently on schedule to complete the transition in the third quarter of fiscal 2006.

      Mesa Air Group recorded consolidated net income of $5.3 million in the second quarter of fiscal 2006, representing diluted earnings per share of $0.14. This compares to consolidated net income of $10.8 million or $0.26 per share in the second quarter of fiscal 2005.

      The following tables set forth quarterly comparisons for the periods indicated below:

OPERATING DATA

CONSOLIDATED FINANCIAL DATA

Note: numbers in table may not recalculate due to rounding

FINANCIAL DATA BY OPERATING SEGMENT

Recent Developments

      During the quarter ended March 31, 2006, holders of $144.8 million in aggregate principal amount due at maturity ($57.5 million carrying amount) of our Senior Convertible Notes due 2023 (the “Notes”) converted Notes into shares of the Company’s common stock. As a result of these conversions, the Company issued 5,751,121 shares of common stock to holders of Notes during the quarter ended March 31, 2006. The shares of common stock issuable upon conversion of the Notes have previously been included in the calculation of diluted earnings per share. Consequently, issuance of the shares will not be further dilutive to reported diluted earnings per share.

RESULTS OF OPERATIONS

      In the quarter ended March 31, 2006, operating revenue increased by $48.3 million, or 18.3%, from $263.8 million in the quarter ended March 31, 2005 to $312.1 million in the quarter ended March 31, 2006. The increase in revenue is primarily attributable to a $38.4 million increase in fuel reimbursements by our code-share partners and a $11.9 million increase in revenue associated with the operation of 8 additional regional jets flown by Mesa/ Freedom compared to the quarter ended March 31, 2005. This increase was partially offset by a net decrease in revenue of approximately $1.2 million at Air Midwest. The decrease in revenue at Air Midwest was primarily comprised of a $0.2 million decrease in passenger revenue and a $1.0 million decrease in Essential Air Program subsidies. The decrease in passenger revenue was due to reduced Beechcraft 1900D capacity from 26 as of March 31, 2005 to 20 as of March 31, 2006 as a result of leasing these aircraft to other carriers.

      In the quarter ended March 31, 2006, flight operations expense increased $11.7 million, or 14.8%, to $90.8 million from $79.1 million for the quarter ended March 31, 2005. On an ASM basis, flight operations expense increased 7.7% to 4.2 cents per ASM in the quarter ended March 31, 2006 from 3.9 cents per ASM in the quarter ended March 31, 2005. At Mesa/ Freedom, flight operations expense increased $14.4 million primarily due to a $8.8 million increase in aircraft lease costs as a result of permanently financing 15 CRJ-900 aircraft as operating leases in the fourth quarter of fiscal 2005 and a $3.6 million increase in pilot and flight attendant wages due to the additional regional jets in service and training costs associated with the transition of aircraft from US Airways to Delta. These costs were partially offset by reduced flight operations expense in the other segment of $2.0 million, which was primarily due to increased amortization of deferred credits, which reduced flight operations expense. The decrease on an ASM basis is due to the addition of larger regional jets at Mesa over the past year and the reduction in turboprop aircraft at Air Midwest.

      In the quarter ended March 31, 2006, fuel expense increased $38.0 million, or 58.2%, to $103.2 million from $65.2 million for the quarter ended March 31, 2005. On an ASM basis, fuel expense increased 46.9% to

4.7 cents per ASM in the quarter ended March 31, 2006 from 3.2 cents per ASM in the quarter ended March 31, 2005. Into-plane fuel cost in the second quarter increased 50% from $1.37 per gallon in the second quarter of fiscal 2005 to $2.05 per gallon in the second quarter of fiscal 2006, resulting in a $32.2 million unfavorable price variance. Consumption increased 6% in the current quarter resulting in an $5.8 million unfavorable volume variance (excluding fuel used in other operations). In the quarter ended March 31, 2006, approximately 97% of our fuel costs were reimbursed by our code-share partners.

      In the quarter ended March 31, 2006, maintenance expense increased $0.7 million, or 1.4%, to $47.6 million from $46.9 million for the quarter ended March 31, 2005. On an ASM basis, maintenance expense decreased 4.3% to 2.2 cents per ASM in the quarter ended March 31, 2006 from 2.3 cents per ASM in the quarters ended March 31, 2005. Mesa/ Freedom’s maintenance expense increased $4.5 million primarily as a result of increases in the number of aircraft in their fleet, repair costs on certain rotable parts, headcount and engine overhaul expenses. The increase was offset by a $2.1 million decrease at Air Midwest as a result of increased maintenance in the second quarter of fiscal 2005 incurred to prepare aircraft for lease; and a $1.8 million decrease in maintenance expense in the Other Segment primarily as a result of reduced engine overhaul expenses in the quarter.

      In the quarter ended March 31, 2006, aircraft and traffic servicing expense increased by $0.7 million, or 4.1%, to $18.3 million from $17.6 million for the quarter ended March 31, 2005. On an ASM basis, aircraft and traffic servicing expense decreased 11.1% to 0.8 cents per ASM in the quarter ended March 31, 2006 from 0.9 cents per ASM in the quarter ended March 31, 2005. At Mesa/ Freedom, aircraft and traffic servicing increased $1.2 million, primarily as a result of a $1.1 million increase in landing fees. The increase at Mesa/ Freedom was offset by a $0.8 million decrease at Air Midwest, primarily a result of reductions in capacity and cities served.

      In the quarter ended March 31, 2006, promotion and sales expense increased by $0.1 million, or 8.2%, to $0.9 million from $0.8 million for the quarter ended March 31, 2005. On an ASM basis, promotion and sales expense now equates to less than $0.1 cent. The decrease in expense is due to a decline in booking and franchise fees paid by Air Midwest under our pro-rate agreements with our code-share partners caused by a decline in passengers carried under these agreements as a result of capacity reductions. We do not pay these fees under our regional jet revenue-guarantee contracts.

      In the quarter ended March 31, 2006, general and administrative expense decreased $1.2 million, or 7.3%, to $14.5 million from $15.7 million for the quarter ended March 31, 2005. On an ASM basis, general and administrative expense decreased 12.5% to 0.7 cents per ASM in quarter ended March 31, 2006 from 0.8 cents per ASM in the quarter ended March 31, 2005. The net decrease was primarily due to a $1.3 million decrease in workers compensation expense as a result of establishing reserves in the prior year, a $1.3 million reduction in Sarbanes Oxley related consulting fees and a $0.4 million reduction in bad debt expense. These increases were offset by a $0.8 million increase in property tax expense due to increases in our fleet of jet aircraft and a $0.6 million increase in stock option expense as a result of the adoption of FASB 123(R).

      In the quarter ended March 31, 2006, depreciation and amortization expense decreased $1.3 million, or 12.7%, to $8.8 million from $10.1 million for the quarter ended March 31, 2005. On an ASM basis, depreciation expense decreased 20% to 0.4 cents per ASM in the quarter ended March 31, 2006 from 0.5 cents per ASM in the quarter ended March 31, 2005. The decrease is primarily due to a $1.0 million reduction in

depreciation expense at Mesa/ Freedom as a result of permanently financing 15 CRJ-900 aircraft as operating leases in the fourth quarter of fiscal 2005 and a $0.3 million reduction in depreciation expense in the other segment as a result of the sale of rotable inventory to AAR in the first quarter of fiscal 2006.

      In the quarter ended March 31, 2006, interest expense decreased $1.5 million, or 14.6%, to $8.7 million from $10.2 million for the quarter ended March 31, 2005. On an ASM basis, interest expense decreased 20% to 0.4 cents per ASM in the quarter ended March 31, 2006 from 0.5 cents per ASM in the quarter ended March 31, 2005. The decrease in interest expense is primarily due to a $0.8 million reduction in convertible debt interest expense as a result of the conversion from debt to equity, a $0.5 million reduction in interest expense related to aircraft financing as a result of permanently financing 15 CRJ-900 aircraft with operating leases in the fourth quarter of fiscal 2005 and a $0.3 million reduction in interest expense related to the financing of rotable inventory that was retired in the first quarter of fiscal 2006.

      In the quarter ended March 31, 2006, interest income increased $2.1 million to $2.6 million from $0.5 million for the quarter ended March 31, 2005. The increase is due to the mix of securities between debt and equity and increases in the rates of return on our portfolio of marketable securities.

      In the quarter ended March 31, 2006, other income (expense) increased $12.1 million from $1.1 million for the quarter ended March 31, 2005 to $13.2 million for the quarter ended March 31, 2006. In the quarter ended March 31, 2006, other income (expense) is primarily comprised of $12.2 million of debt conversion costs and $0.7 million in unrealized losses on investment securities.

      In the quarter ended March 31, 2005, other income (expense) is primarily comprised of an investment loss of $2.7 million related to our portfolio of aviation related securities and $1.0 million in income from a settlement of a dispute with a vendor.

      In the quarter ended March 31, 2006, income tax expense decreased $3.4 million, or 50.8%, to $3.3 million from $6.7 million for the quarter ended March 31, 2005. The effective tax rate increased from 38.3% for the quarter ended March 31, 2005 to 38.5% for the quarter ended March 31, 2006 mainly as a result of increased flying in states with higher tax rates.

      In the six months ended March 31, 2006, operating revenue increased by $107.1 million, or 20.3%, from $528.6 million in the six months ended March 31, 2005 to $635.7 million in the six months ended March 31, 2006. The increase in revenue is primarily attributable to a $80.0 million increase in fuel reimbursements by our code-share partners and a $36.8 million increase in revenue associated with the operation of 8 additional regional jets flown by Mesa/ Freedom compared to the six months ended March 31, 2005. This increase was partially offset by a net decrease in revenue of approximately $10.0 million at Air Midwest. The decrease in revenue at Air Midwest was primarily comprised of a $7.7 million decrease in passenger revenue and a $2.3 million decrease in Essential Air Program subsidies. The decrease in passenger revenue was due to reduced Beechcraft 1900D capacity from 26 as of March 31, 2005 to 20 as of March 31, 2006 as a result of leasing these aircraft to other carriers.

      In the six months ended March 31, 2006, flight operations expense increased $22.4 million, or 14.1%, to $180.7 million from $158.3 million for the six months ended March 31, 2005. On an ASM basis, flight operations expense increased 2.6% to 4.0 cents per ASM in the six months ended March 31, 2006 from 3.9 cents per ASM in the six months ended March 31, 2005. At Mesa/ Freedom, flight operations expense increased $27.0 million primarily due to a $18.2 million increase in aircraft lease costs as a result of permanently financing 15 CRJ-900 aircraft as operating leases in the fourth quarter of fiscal 2005, a $5.6 million increase in pilot and flight attendant wages due to the additional regional jets in service and training costs associated with the transition of aircraft from US Airways to Delta and a $1.1 million increase in lodging costs associated with relocating crews to new domiciles. These costs were partially offset by reduced flight operations expense at Air Midwest of $0.9 million, which was primarily comprised of decreased wages and training costs of $1.2 million and reduced flight operations expense in the other segment of $1.6 million, which was primarily comprised of increased amortization of deferred credits, which reduced flight operations expense. The decrease on an ASM basis is due to the addition of larger regional jets at Mesa over the past year and the reduction in turboprop aircraft at Air Midwest.

      In the six months ended March 31, 2006, fuel expense increased $75.7 million, or 57.2%, to $208.0 million from $132.3 million for the six months ended March 31, 2005. On an ASM basis, fuel expense increased 39.4% to 4.6 cents per ASM in the six months ended March 31, 2006 from 3.3 cents per ASM in the six months ended March 31, 2005. Into-plane fuel cost in the six months ended March 31, 2006 increased 48% from $1.38 per gallon in the six months ended March 31, 2005 to $2.04 per gallon in the six months ended March 31, 2006, resulting in a $62.8 million unfavorable price variance. Consumption increased 7% in the six months ended March 31, 2006 resulting in a $13.4 million unfavorable volume variance (excluding fuel used in other operations). In the six months ended March 31, 2006, approximately 97% of our fuel costs were reimbursed by our code-share partners.

      In the six months ended March 31, 2006, maintenance expense increased $7.6 million, or 8.0%, to $103.1 million from $95.5 million for the six months ended March 31, 2005. On an ASM basis, maintenance expense decreased 4.2% to 2.3 cents per ASM in the six months ended March 31, 2006 from 2.4 cents per ASM in the six months ended March 31, 2005. Mesa/ Freedom’s maintenance expense increased $12.3 million primarily as a result of increases in the number of aircraft in their fleet, repair costs on certain rotable parts, headcount and engine overhaul expenses. The increase was offset by a $5.0 million decrease at Air Midwest as a result of increased maintenance in fiscal 2005 incurred to prepare aircraft for lease.

      In the six months ended March 31, 2006, aircraft and traffic servicing expense increased by $0.1 million, or 0.4%, to $34.5 million from $34.4 million for the six months ended March 31, 2005. On an ASM basis, aircraft and traffic servicing expense decreased 11.1% to 0.8 cents per ASM in the six months ended March 31, 2006 from 0.9 cents per ASM in the six months ended March 31, 2005. At Mesa/ Freedom, aircraft and traffic servicing increased $1.9 million, primarily as a result of a $1.0 million increase in landing fees and a $0.9 million increase in TSA security costs. The increase at Mesa/ Freedom was offset by a $1.8 million decrease at Air Midwest, primarily a result of reductions in capacity and cities served.

      In the six months ended March 31, 2006, promotion and sales expense decreased by $0.5 million, or 23.4%, to $1.7 million from $2.2 million for the six months ended March 31, 2005. On an ASM basis, promotion and sales expense now equates to less than $0.1 cent. The decrease in expense is due to a decline in

booking and franchise fees paid by Air Midwest under our pro-rate agreements with our code-share partners caused by a decline in passengers carried under these agreements as a result of capacity reductions. We do not pay these fees under our regional jet revenue-guarantee contracts.