UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Commission file no. 1-7134

Mercury Air Group, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(310) 827-2737

      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 þ          No o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes o          No þ

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

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes to consolidated financial statements.

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

      Non-Cash investing and financing activities are excluded from the consolidated statement of cash flows. On November 10, 2004, the Company entered into an amended lease agreement with CFK Realty and amended the terms of the note receivable due from CFK Realty. The Company reduced the note receivable from CFK Realty by $796,000 and reduced the deferred gain on sale of the building by the same amount. See Note 11. During the second quarter of 2005, the Company upgraded its 12.5% ownership interest in a BeechJet 400A aircraft to a 12.5% interest in a Raytheon Hawker 800XP. The Company received a $443,750 trade-in allowance for its 12.5% ownership in the Beechjet.

See accompanying notes to consolidated financial statements.

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

See accompanying notes to consolidated financial statements.

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2005

(Unaudited)

      Mercury Air Group, Inc. (the “Company”), a Delaware corporation, was organized in 1956 and provides a broad range of services to the aviation industry through three principal operating units which are all wholly owned subsidiaries of the Company: MercFuel, Inc. (“MercFuel”), a Delaware corporation, Mercury Air Cargo, Inc. (“Air Cargo”), a California corporation, and Maytag Aircraft Corporation (“Maytag”), a Colorado corporation. MercFuel’s operations consist of the sale and delivery of fuel, primarily aviation fuel, to domestic and international commercial airlines, fractional jet ownership companies, corporate aviation fleets and air cargo companies. Air Cargo’s operations consist of cargo handling, the sale of cargo capacity on other airlines (“Cargo Space Logistics”), and general cargo sales agent services. Maytag is a provider of governmental contract services performing aircraft refueling and fuel storage operations, base operations support (“BOS”) services, air terminal and ground handling services and weather observation and forecasting services primarily for agencies of the government of the United States of America.

      Through April 12, 2004, the Company operated a fourth operating unit, Mercury Air Centers, Inc. (“Air Centers”). Air Centers’ operations consisted of aviation fuel sales, aircraft refueling operations (“into-plane”), aircraft ground support services, aircraft hangar services, aircraft parking (“aircraft tie-down services”) and aircraft maintenance at certain Air Center locations, known as Fixed Based Operations (“FBO’s”). On April 12, 2004 (the “FBO Sale Closing Date”), following stockholder approval, the Company sold all of Air Centers outstanding common stock to Allied Capital Corporation (“Allied”) for $76,349 thousand subject to adjustments for, among other things, Air Centers’ net working capital as of the FBO Sale Closing Date and the distribution of funds from an escrow account established at closing associated with the Air Centers’ Hartsfield International Airport FBO (the “Hartsfield FBO”). The net working capital adjustment was finalized during the second quarter of fiscal 2005. See Note 12 for details. The assets sold through the sale of the stock of Air Centers (the “FBO Sale”) consisted of all of the assets of the Company’s FBO business excluding the Company’s FBO at the Long Beach Airport (“Long Beach”) which the Company has retained and continues to operate under a profit sharing arrangement.

      As used in this Quarterly Report on Form 10-Q, the term “Company” or “Mercury” refers to Mercury Air Group, Inc. and, unless the context otherwise requires, its subsidiaries. The Company’s principal executive offices are located at 5456 McConnell Avenue, Los Angeles, California, 90066 and its telephone number is (310) 827-2737.

      Accounts receivable is comprised primarily of trade receivables from customers and is net of an allowance for doubtful accounts. The Company’s credit risk is based in part on the following: 1) substantially all receivables are related to the aviation industry, 2) there is a concentration of credit risk as there are several customers who at any time have significant balances owed to the Company, and 3) significant balances are owed by certain customers that are not adequately capitalized. In addition, significantly higher fuel prices for extended periods of time may have a negative impact on the aviation industry as it substantially increases airlines’ operating expenses. Smaller airlines with lower levels of capital may be more seriously impacted. The Company assesses its credit portfolio on an ongoing basis and establishes allowances which it believes are adequate to absorb potential credit problems that can be reasonably anticipated.

      The Company purchases aviation fuel from a limited number of suppliers. If the Company’s relationship with any of these key suppliers terminates, the Company may not be able to obtain a sufficient quantity of aviation fuel on favorable terms or may experience difficulty in obtaining aviation fuel from alternative

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

suppliers. Furthermore, difficulties faced by these suppliers or aviation fuel shortages or the inability to obtain aviation fuel from alternate sources at acceptable prices and terms could impair the Company’s ability to sell aviation fuel to its customers at competitive prices and terms.

      The Company may experience decreases in future sales volume and margins as a result of deterioration in the world economy, or in the aviation industry, and continued conflicts and instability in the Middle East, Asia and Latin America, as well as a result of potential future terrorist activities and possible military retaliation. Through the Company’s first nine months of fiscal 2005, petroleum product prices, including aviation fuel, have either achieved or been close to historical high levels. This sustained price level places additional financial burden on many of the Company’s customers. If the Company’s customers are not able to pass on the higher petroleum product prices to their customers, they may experience financial hardship which may result in the Company experiencing longer collection terms, which will place additional financial burden on the Company, or higher level of uncollectible accounts.

      The accompanying unaudited financial statements of the Company have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments consisting of normal recurring adjustments and accruals necessary for a fair presentation have been reflected in these financial statements. Operating results for the quarter are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2005 due to seasonal and other factors. In order to maintain consistency and comparability between periods presented, certain prior period amounts have been reclassified to conform to the current period presentation. The accompanying financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004.

      Certain reclassifications have been made to prior quarter amounts to conform with current quarter presentation.

      On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment” (“SFAS No. 123R”). This standard requires companies to expense the value of employee stock options and similar awards. Under SFAS No. 123R, share-based payment (“SBP”) awards result in a cost that will be measured at fair value on the awards’ grant date, based on the estimated number of awards that are expected to vest. Compensation cost for awards that vest would not be reversed if the awards expire without being exercised. When measuring fair value, companies can choose an option-pricing model (e.g., Black-Scholes or binomial models) that appropriately reflects their specific circumstances and the economics of their transactions. Companies will recognize compensation cost for SBP awards as they vest including the related tax effects. Upon settlement of SBP awards, the tax effects will be recognized in the income statement or additional paid-in capital. Public companies are allowed to select from two alternative transition methods. The effective date for public companies is annual periods beginning after June 15, 2005, and applies to all outstanding and unvested SBP awards at a company’s adoption date. The Company is currently evaluating the potential impact of the adoption of SFAS 123R.

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 2 — Stock-Based Employee Compensation

      The Company has four stock option plans. As permitted under SFAS No. 123, “Accounting for Stock-Based Compensation”
(“SFAS No. 123”), and as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“SFAS No. 148”), the Company measures compensation expense related to employee stock options granted utilizing the intrinsic value method as prescribed by Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. The following table illustrates the pro forma effect on net loss if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.

      Income tax expense has been computed based on the estimated annual effective income tax rate for the respective periods adjusted for significant events that have occurred during the respective periods that are not expected to recur in future periods. The effective income tax rate from continuing operations was 27.0% and 14.3% for the three month periods ended March 31, 2005 and 2004, respectively. The effective income tax rate from continuing operations was 26.2% and 8.0% for the nine month periods ended March 31, 2005 and 2004, respectively.

      The effective income tax rate from continuing operations for the three month and nine month periods ended March 31, 2004 included the results of operations for the Air Centers. The consolidated statements of operations for the three month and nine month periods ended March 31, 2005 were restated to reflect the Air Center results as “Discontinued Operations”. With this restatement, the effective tax rate from continuing operations for the three month and nine month periods ended March 31, 2004 would have been 14.4% (benefit) and 1.7% (expense), respectively, and 14.2% (benefit) and 25.6% (benefit), respectively, for discontinued operations.

      The settlement costs related to J.O. Hambro of $1,799 thousand recognized by the Company in the second quarter of fiscal 2004 is not deductible in the determination of taxable income resulting in a permanent book to tax difference. The difference resulted in an increase in the income tax provision for the three and nine month periods ended March 31, 2004.

      On March 14, 2003 the Company received a Notice of Violation from the United States Environmental Protection Agency (“EPA”) alleging certain deficiencies in the Company’s spill prevention, control and countermeasure plan (“SPCC Plan”) for the Air Centers’ Fort Wayne, Indiana facility (“Ft. Wayne

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Facility”). The Company believes that it has resolved all deficiencies except for alleged deficiencies related to: 1) secondary containment for refueling trucks, and 2) secondary containment for discrete fuel loading areas. Pursuant to an agreement detailed in a letter submitted to the EPA on April 16, 2003, the Company was permitted to suspend modifications to its SPCC Plan regarding the installation of secondary containment for its parked refueling trucks and loading areas, pending resolution of federal regulatory issues associated with SPCC requirements.

      The Stock Purchase Agreement between the Company and Allied dated as of October 28, 2003 regarding the sale of all of the outstanding stock owned by the Company in Air Centers (the “Air Centers’ SPA”), provides that the Company shall be responsible for compliance, for a period of eighteen months subsequent to the FBO Sale Closing Date, for any secondary containment (as the term is defined in the Air Centers’ SPA) required by any applicable governmental authority pursuant to environmental law for extended or overnight fuel truck parking at any FBO comprising the FBO business on the FBO Sale Closing Date.

      Pursuant to a letter dated October 18, 2004 from EPA to the Ft. Wayne facility, EPA demanded the installation of secondary containment at the Ft. Wayne Facility for parked refueling trucks (but not loading areas). While the Company does not believe the SPCC Plan requirements regarding containment are applicable to mobile refueling trucks, it agreed to indemnify Air Centers for the reasonable cost of installation of such containment at the Ft. Wayne Facility in order to avoid further transaction costs. It did not admit that such indemnification was required under the Air Centers SPA or environmental law. The containment was installed in March 2005. The Ft. Wayne Facility’s SPCC Plan is currently being revised and certified to reflect the installation. It will then be submitted to the EPA.

      In the opinion of management, the resolution of this matter, including the installation of any secondary containment at other Air Centers facilities, is not expected to have a material effect on the Company’s results of operations, cash flow or financial position.

      On November 26, 2003, Signature Flight Support Corporation filed a complaint against Air Centers and Allied alleging: 1) breach of contract against Mercury Air Centers; 2) tortious interference with contract against Allied; 3) tortious interference with prospective economic advantage against Allied; and 4) unfair business practices against Mercury and Allied. The Company has agreed to indemnify Allied and its affiliates (including, without limitation, Air Centers after the closing of the FBO sale), directors, officers, agents, employees and controlling persons from any liability, obligation, losses or expenses to which Allied may become subject as a result of the complaint. On January 25, 2005 the United States District Court for the Central District of California entered an order granting in part and denying in part Mercury Air Group’s motion for Summary Judgment or alternatively partial summary judgment and an order granting Allied Capital Corporation’s motion for Summary Judgment. Under this order Allied Capital was completely removed from the case and was granted all relief requested. In regards to Mercury Air Group, Inc. the court found that there was a genuine issue of material fact as to whether or not Signature was entitled to its due diligence expenses. Subsequently the parties stipulated that Signature’s recoverable damages in the event Signature subsequently proves the existence of a binding contract and a material breach by Mercury are to be $160,000. Signature has given notice of appeal in this case. On April 18, 2005 in the companion case between the parties and others filed in the Superior Court of the State of California for the County of Los Angeles the parties entered into a Joint Stipulation Continuing Case Management Conference which continued all matters in the cause of action until after the next Case Management Conference which was reset until May 26, 2005 with Case Management Statements to be filed on May 19, 2005 to allow the parties to discuss a global settlement. On May 18, 2005 the parties filed a further stipulation continuing the Case Management Conference until July 27, 2005 and the filing of the Case Management Statements until July 20, 2005. On May 18, 2005 the parties filed a further stipulation continuing the Case Management Conference until July 27, 2005 and the filing of the Case Management Statements until July 20, 2005. The Company believes these allegations have no merit and will also be vigorously disputed and defended. In the opinion of

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

management, the ultimate resolution of these complaints will not have a material effect on the Company’s consolidated financial statements but the cost of litigation has had a material impact on the results for the third quarter of fiscal year 2005.

      On July 14, 2004, Leon Shabott filed suit in the United States District Court, District of Massachusetts against Mercury Air Group, Inc. for damages arising out of the repair of Beechcraft twin Bonanza aircraft engines in June of 1998 claiming damages of up to $150 thousand. The Company believes that the claim is barred by the statute of limitations and that it has other good and viable defenses as well. In the opinion of management, the ultimate resolution of this matter is not expected to have a material effect on the Company’s results of operations, cash flows or financial position.

      On April 28, 2005 notice of a complaint being filed in the United States District Court of the Southern District of Illinois by Mr. Lambert against BP Products, et al and Maytag Aircraft Corporation was received. The original complaint had been amended to include Maytag Aircraft Corporation as a named defendant which includes a number of jet fuel retailers. Plaintiff alleges that the defendants caused him personal injury and other damage as a result of his exposure to jet fuel products while in the Marines. This matter is currently under investigation, however, Mercury does not believe this matter will have a significant impact on its financial position or operating results.

      On May 2, 2005 notice of action against Mercury Air Cargo, Inc. filed in the Superior Court of Los Angeles County for an accident which occurred on May 6, 2003 was received. Plaintiff claims that her heel was run over by a fork lift while she was working as a government inspector. The Company is investigating the matter. The matter has been turned over to Mercury’s insurance company and insurance counsel for handling. However, the Company does not believe that this matter will have a significant impact on its financial position or operating results.

      The Company is also a defendant in certain litigation arising in the normal course of business. In the opinion of management, the ultimate resolution of such litigation will not have a material effect on the Company’s results of operations, cash flows or financial position. Reference is made to the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2004 for additional legal matters with respect to which no material developments have occurred in the current quarter.

      Restricted cash consists of cash held for specific purposes and not available for general use by the Company. Restricted cash as of March 31,2005 is comprised of: 1) $95 thousand on deposit with Wells Fargo Foothill as reserve for outstanding letters of credit fees; and 2) $8,355 thousand for an escrow account established on the FBO Sale Closing Date associated with the Hartsfield FBO (the “Harstfield Escrow Account”). The funds held in the Hartsfield Escrow Account are to be distributed to either one or both of the Company and Allied over a period not to exceed five years from the FBO Sale Closing Date dependent upon the award of a new lease at the Hartsfield International Airport in Atlanta for a new FBO. Dependent upon the effective date of the new lease and the terms and conditions of the new lease, the Company may be entitled to all, some or none of the amount deposited into the Hartsfield Escrow Account at closing.

      On October 11, 2004, the city of Atlanta notified Air Centers that it planned on entering into lease negotiations with a different company for the FBO at the Hartsfield International Airport under the then existing RFP process. On November 22, 2004, Air Centers was notified by the airport authority that the matter would be re-bid. The re-bid process is currently underway. If a new FBO lease at the Hartsfield International Airport is not awarded to Air Centers, the amount remaining undistributed in the Hartsfield Escrow Account on the date that Air Centers ceases operating the Hartsfield FBO will be distributed to Allied. The first installment of $1,654 thousand was received on April 12, 2005.

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      On July 29, 2004, the Company and Bank of America, N.A. (“Bank of America”) entered into a three-year $30,000 thousand revolving line of credit (the “B of A Credit Facility”) collateralized by all of the assets of the Company, the terms of which were amended by the First Amendment to the Loan Agreement effective November 1, 2004 (the “First Amendment”), by the Second Amendment to the Loan Agreement effective January 31, 2005 (the “Second Amendment) and by the Third Amendment to the Loan Agreement effective April 6, 2005 (the “Third Amendment”). The loan agreement, as amended, will expire on July 31, 2007, or earlier under certain conditions. Upon the effective date of the B of A Credit Facility, $15,414 thousand of cash deposited by the Company as collateral for outstanding letters of credit and reported as restricted cash on the Company’s balance sheet at June 30, 2004 was released to the Company for general corporate purposes. In accordance with the terms of the loan agreement, as amended, the revolving line of credit is used as collateral for any letter of credit issued by the Company and for general working capital needs. The amount of credit available to the Company on the B of A Credit Facility, as amended, is determined monthly and is equal to the lesser of 80% of the balance due on Domestic Eligible Receivables, and 2) $30,000 thousand. The B of A Credit Facility, as amended, contains certain financial covenants limiting the amount the Company can expend annually for capital expenditures to $2,000 thousand. The B of A Credit Facility, as amended, also prohibits the repurchase of stock and the payment of cash dividends, except for cash dividends in an amount not to exceed $17,500 thousand by June 30, 2005, and stock purchases in an amount not to exceed $1,000 thousand by June 30, 2005. The Company paid a cash dividend of $17,500 thousand on November 5, 2004. The Company is also required to maintain certain financial targets for tangible net worth and fixed charges. As of March 31, 2005, the Company was not in compliance with the tangible net worth and fixed charges financial targets. A waiver was received from Bank of America.

      On November 2, 2004, the Company requested and received a cash advance on the B of A Credit Facility in the amount of $10,000 thousand. The funds received as a cash advance were used to fund the one-time special cash dividend and to meet on-going working capital requirements. As of March 31, 2005, the Company’s borrowing under the revolving credit line was $7,500 thousand.

      As of March 31, 2005, the Company had $30,000 thousand of revolving credit line available under the B of A Credit Facility, of which $15,456 thousand was reserved for issued and outstanding letters of credit and $7,044 thousand was available and undrawn.

      On November 1, 2004, the Company and Bank of America entered into a Letter of Credit and Reimbursement Agreement (the “LOC and Reimbursement Agreement”) relating to the outstanding tax exempt bonds issued in 1998 pursuant to a loan agreement between the Company and the California Economic Development Financing Authority (“CEDFA”). As of November 1, 2004, the outstanding principal amount of the bonds outstanding was $14,000 thousand. In accordance with the terms of the LOC and Reimbursement Agreement, Bank of America has issued an irrevocable direct pay letter of credit to the trustee for the bondholders in an amount of $14,161 thousand (the “CEDFA LOC”) that replaced the previously existing irrevocable direct pay letter of credit of the same amount issued by Wells Fargo Bank, N.A. on behalf of the Company, which was cancelled simultaneously with the issuance of the CEDFA LOC. In addition to the issuance of the CEDFA LOC, the LOC and Reimbursement Agreement require the Company to call for redemption bonds in the principal amount of $500 thousand on each of April 1 and October 1 commencing on April 1, 2005. The CEDFA LOC was issued by Bank of America as part of the B of A Credit facility.

      The Company owned a 69.6% equity interest in MercMed LLC (“MercMed”), which was formed in 1998 for the purpose of owning and operating an aircraft for the MercMed members. As a result of the age of the MercMed aircraft, changes in Federal Aviation Administration requirements restricting the altitude at

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

which the MercMed aircraft can fly, the popularity of fractional jet ownership versus outright aircraft ownership and the technological advancements in aircraft design and construction, it was determined that the current market value of the MercMed aircraft was below the carrying value of the aircraft. During the first quarter of fiscal 2005, the book value of the MercMed aircraft was adjusted to reflect the current market value as determined by the MercMed members, which was determined to be $532 thousand. This adjustment to market value resulted in an asset impairment loss of $626 thousand.

      On November 10, 2004, the Company, upon authorization from the Company’s Board of Directors, entered into an agreement to sell all of its rights, title and interest in MercMed to Dr. Fagan. In accordance with the agreement between the Company and Dr. Fagan, the Company has agreed to pay for certain costs incurred by MercMed prior to October 1, 2004 and to provide Dr. Fagan with jet fuel in an amount not to exceed $75 thousand over a five year period. Dr. Fagan has agreed to pay the debt service costs, including the outstanding principal associated with MercMed’s loan and to hold the Company harmless in regard to this loan. As of December 31, 2004, the financial statements of MercMed are no longer included in the Company’s consolidated financial statements.

      Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares and dilutive common stock equivalents. Common stock equivalents include stock options and shares resulting from the assumed conversion of subordinated debentures, when dilutive. Nonqualified stock options totaling approximately 426 thousand and 558 thousand for the third quarter of 2005 and 2004, respectively, and options totaling approximately 498 thousand and 564 thousand for the nine months ended March 31, 2005 and March 31, 2004, respectively, were excluded from the calculation of diluted net income per common share because they were anti-dilutive.

      The Company discloses segment information in accordance with SFAS No. 131, “Disclosure About Segments of an Enterprise and Related Information,” which requires companies to report selected segment information on a quarterly basis and to report certain entity-wide disclosures about products and services, major customers and material countries in which the entity holds assets and reports revenues. The operating

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

segments reported below are the segments of the Company for which operating results are evaluated regularly by management in deciding how to allocate resources and in assessing performance.

      The Company operates and reports its activities through three principal units: MercFuel, Air Cargo and Maytag. Air Centers was sold on April 12, 2004. As a result, Air Centers’ historical operating results have been reclassified as discontinued operations. The segment data included below have been restated to exclude amounts related to Air Centers.

      Gross margin is used as the measure of profit and loss for segment reporting purposes as it is viewed by key decision makers as the principal operating indicator in measuring segment profitability. The key decision makers also view bad debt expense as an important measure of profit and loss. The predominant component of bad debt expense relates to MercFuel. Bad debt expense for MercFuel was approximately $1,153,000 and $293,000 for the quarters ended March 31, 2005 and 2004, respectively; total bad debt expense was $1,150,000 and $329,000 in the quarters ended March 31, 2005 and 2004, respectively. Bad debt expense for MercFuel

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

was approximately $1,453,000 and $113,000 for the nine month periods ended March 31, 2005 and 2004, respectively; total bad debt expense was $1,514,000 and $305,000 for the nine month periods ended March 31, 2005 and 2004, respectively. The second quarter of 2004 included a bad debt benefit of $329,000 at MercFuel. One of MercFuel’s foreign customers has entered into a reorganization proceeding, similar to Chapter 11 of the United States Bankruptcy Code, and continues to operate on a prepay basis with the Company. At the time of filing, approximately $1,446,000 was owed to the Company. The increase in bad debt expense for the quarter ended March 31, 2005 included an additional $1,000,000 expense to fully reserve this receivable.

      Comprehensive income (loss) is summarized as follows:

      CFK Partners was a partnership consisting of three of the Company’s directors, one of whom also serves as the Company’s Chief Executive Officer, another who served as Chairman of the Board of Directors and the third who serves as a director and is the Company’s primary outside legal counsel. In July 2004, after the retirement of Dr. Fagan as the Company’s Chairman of the Board of Directors, Dr. Fagan withdrew as a member of CFK Partners. The remaining members of CFK Partners, now known as CK Partners, are the Company’s Chief Executive Officer and Frederick H. Kopko, Jr., a member of the Company’s Board of Directors. As of March 31, 2005, CK Partners owned approximately 43% of the Company’s outstanding common stock.

      Pursuant to the terms of Dr. Fagan’s contract with the Company, upon Dr. Fagan’s retirement as Chairman of the Board of Directors in July 2004, the Company paid Dr. Fagan a bonus and severance payment of $1,890 thousand. This amount was accrued at June 30, 2004.

      In January 2002, the Company sold the land and office building which houses its corporate headquarters to CFK Realty Partners, LLC (“CFK Realty”) for $4,200 thousand, consisting of $2,800 thousand in cash and a note receivable of $1,400 thousand. The note accrued interest at 5% and contained provisions whereby CFK Realty could elect to extend the maturity date in one-year increments through December 31, 2004. The note had an original maturity date of December 31, 2002. In early December 2002 and 2003, the Company received notification from CFK Realty that it was exercising its right to extend the maturity date of the note for an additional one year period. Concurrently with the sale, the Company also entered into a twenty-year lease of the property for a monthly rental amount of approximately $37 thousand. During fiscal 2003, the Company expended $275 thousand for leasehold improvements on its corporate headquarters. This amount is being amortized over the office lease term. CFK Realty financed the purchase of the headquarters through a $3,200 thousand loan. In July 2004, CFK Realty was restructured whereby Dr. Fagan, the retired Chairman of the Company’s Board of Directors, became the sole member of CFK Realty. Effective July 2004, CFK Realty is no longer considered a related party and the financial statements of CFK Realty are no longer included in the Company’s consolidated financial statements.

      On November 10, 2004, the Company, upon authorization from the Company’s Board of Directors, entered into an amended lease agreement with CFK Realty and amended the terms of the note receivable due

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

from CFK Realty (the “CFK Realty Note”). The amended terms of the lease, which were effective retroactively to July 1, 2004, provide for a ten-year lease with CFK Realty having the right, after the refinancing of its existing loan secured by the office building, to request the Company to vacate the facility at the end of five years without any additional obligation from the Company with CFK Realty continuing to honor the terms of any sublease the Company may have arranged under the McConnell Lease. The monthly lease rate remains unchanged from the original lease at $37 thousand. The Company also agreed to amend the terms of the CFK Realty Note to reduce the principal amount of the note to $779 thousand, from the previous principal amount of $1,400 thousand plus accrued interest of $179 thousand, at an interest rate of 4% per annum. The CFK Realty Note is payable on December 31, 2009.

      The Company uses the services of the legal firm McBreen and Kopko (the “Firm”) for various general corporate legal matters. Mr. Frederick H. Kopko, Jr., a partner of the Firm, is a member of the Company’s Board of Directors and is a member of CK Partners. For the nine month periods ended March 31, 2005 and 2004, the Company paid the Firm $749 thousand and $679 thousand, respectively, for legal services rendered by the Firm. For the three month periods ended March 31, 2005 and 2004, the Company paid the Firm $275 thousand and $198 thousand, respectively, for legal services rendered by the Firm.

      On April 12, 2004, after receiving approval from the Company’s stockholders at the Annual Stockholders’ meeting, the Company sold all of the outstanding common stock of Air Centers to Allied with the Company receiving total consideration for the sale in cash at closing of $76,349 thousand subject to adjustments for, among other things, Air Centers’ net working capital as of the FBO Sale Closing Date and the distribution of funds from the Hartsfield Escrow Account.

      On December 6, 2004, the Company, Allied and Air Centers agreed that Air Centers’ Closing Working Capital as of April 12, 2004 as defined in the Stock Purchase Agreement dated as of October 28, 2003 by and among the Company, Allied and MAC, as amended, (the “SPA”) was $5,307 thousand. The SPA provided that: 1) Allied would pay the Company the amount by which the closing working capital exceeded $3,586 thousand (the “Working Capital Target”), or 2) the Company would pay Allied the amount by which the Working Capital Target exceeded the Closing Working Capital. The Company received $900 thousand in July 2004 from Allied as an initial payment of the amount expected to be due the Company as a result of the Closing Working Capital exceeding the Working Capital Target and $738 thousand on December 6, 2004 as a final payment, which includes accrued interest of $48 thousand and is net of $132 thousand due Allied for reimbursement of certain regulatory compliance improvements as provided for in the SPA.

      In addition to the final payment associated with the Closing Working Capital, Allied and Air Centers agreed to assign to the Company all of Air Centers’ rights, title and interest to Air Centers’ pre-petition claims associated with Hawaiian Airlines in the amount of $329 thousand. The Company has written-off the entire receivable. Hawaiian Airlines, a customer of both the Company and Air Centers, filed for bankruptcy protection under Chapter 11, Title 11 of the United States Bankruptcy Code on March 21, 2003.

      The Company reported a gain on the sale of discontinued operations, net of income taxes of $14 thousand, of $22 thousand in the second quarter of fiscal 2005.

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following are the results of operations of Air Centers for the nine month and three month periods ended March 31, 2004:

      On October 6, 2004, the Company announced that its Board of Directors declared a one-time special cash dividend totaling $17,500 thousand, that would be payable on a pro rata basis to holders of record of its common stock as of the close of business on October 18, 2004. The dividend was paid on November 5, 2004. Based on 3,056,355 shares of its common stock outstanding as of the close of business on October 18, 2004, the dividend payable per common share was $5.70. The amount payable per share of common stock was net of the mandatory dividend payments of approximately $70 thousand on the Company’s outstanding Series A 8% Cumulative Convertible Preferred Stock (the “Preferred Stock”) as of the dividend payment date of November 5, 2004. This one-time special cash dividend was funded, in part, by a cash advance on the B of A Credit Facility in the amount of $10,000 thousand.

Note 14 — Purchase Commitments

      On January 14, 2005, the Company was notified that its Maytag subsidiary was awarded a contract modification on an existing government contract. The term of agreement is through September 30, 2008. As part of the contract, the Company is committed to provide equipment totaling approximately $1,338 thousand.

      On April 6, 2005, Mercury Air Group, Inc. (the “Company”) and Bank of America, N.A. (the “Lender”) executed the Third Amendment to Loan Agreement (the “Third Amendment”) that amends certain terms and conditions to the Loan Agreement dated as of July 29, 2004 between the Company and the Lender, as previously amended. The Loan Agreement, as amended by the Third Amendment, will expire on July 31, 2007, or earlier under certain conditions, and provides for cash advances and letters of credit up to the lesser of $30,000,000 or the Borrowing Base (the “Credit Facility”). The Borrowing Base, as defined in the Credit Facility, as amended by the Third Amendment, is determined monthly and will be equal to 80% of the balance due on Domestic Acceptable Receivables. The Credit Facility, as amended, continues to bear interest equal to the Bank’s Prime Rate.

      The Credit Facility, as amended, continues to contain certain financial covenants limiting the amount the Company can expend annually for capital expenditures to $2,000 thousand. The Credit Facility, as amended, also continues to prohibit the repurchase of stock and the payment of cash dividends, except for cash dividends in an amount not to exceed $17,500 thousand, which amount was expended in November 2004, and repurchases of stock in an amount not to exceed $1,000 thousand, by June 30, 2005. The Company will also continue to be required to maintain certain financial targets for tangible net worth and fixed charges. As of March 31, 2005, the Company was not in compliance with the tangible net worth and fixed charges financial targets. A waiver was received from Bank of America.

MERCURY AIR GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      On April 1, 2005, the Company filed a preliminary proxy with the SEC pursuant to the resolution passed by the Board of Directors on March 22, 2005 to amend its certificate of incorporation, which, if approved by Mercury’s stockholders, would result in a one-for-501 reverse stock split of Mercury’s common stock followed by a 501-for-one forward stock split. See Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional discussion on this matter.

      On the 17^th day of May, 2005 the law firm of Diamond McCarthy filed suit in the 215^th District Court of Harris County, Texas against Mercury Air Group, Inc. and Mercury Air Centers, Inc for damages in the amount of $627,557.50 plus cost of court and attorney fees arising out of a fee dispute in the Signature case (See Litigation Proceedings for a description of the Signature matter). The Company is in the process of evaluating its response in this matter. While no litigation has been filed, the Company is also disputing legal bills from the firms of Bingham McCutchen in the amount of $436,489 and Sheppard Mullin in the amount of $712,875 also arising out of the Signature matter. As of March 31, 2005, these amounts were fully accrued.

      Overview — Mercury Air Group, Inc. (the “Company”), a Delaware corporation, was organized in 1956 and provides a broad range of services to the aviation industry through three principal operating units which are all wholly owned subsidiaries of the Company: MercFuel, Inc. (“MercFuel”), a Delaware corporation, Mercury Air Cargo, Inc. (“Air Cargo”), a California corporation, and Maytag Aircraft Corporation (“Maytag”), a Colorado corporation. MercFuel’s operations consist of the sale and delivery of fuel, primarily aviation fuel, to domestic and international commercial airlines, fractional jet ownership companies, corporate aviation fleets and air cargo companies. Air Cargo’s operations consist of cargo handling, the sale of cargo capacity on other airlines (“Cargo Space Logistics”), and general cargo sales agent services. Maytag is a provider of governmental contract services performing aircraft refueling and fuel storage operations, base operations support (“BOS”) services, air terminal and ground handling services and weather observation and forecasting services primarily for agencies of the government of the United States of America. The assets sold through the sale of the stock of Air Centers (the “FBO Sale”) consisted of all of the assets of the Company’s FBO business excluding the Company’s FBO at the Long Beach Airport (“Long Beach”) which the Company has retained and continues to operate under a profit sharing arrangement.

      As used in this Quarterly Report on Form 10-Q, the term “Company” or “Mercury” refers to Mercury Air Group, Inc. and, unless the context otherwise requires, its subsidiaries. The Company’s principal executive offices are located at 5456 McConnell Avenue, Los Angeles, California, 90066 and its telephone number is (310) 827-2737.

      Forward-Looking Statements — This Quarterly Report on Form 10-Q and the information incorporated by reference in it includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company intends the forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in these sections. All statements regarding the expected financial position and operating results, business strategy, financing plans and forecasted demographic and economic trends relating to the industry are forward-looking statements. These statements can sometimes be identified by the use of forward-looking words such as “may”, “will”, “anticipate”, “estimate”, “expect” or “intend” and similar expressions. These statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements to be materially different from the results, performance or achievements expressed or implied by the forward-looking statements. The Company cannot promise you that the expectations in such forward-looking statements will turn out correct. Factors that impact such forward-looking statements include, but are not limited to, quarterly fluctuations in results; the management of growth; fluctuations in world oil prices, interest rates or foreign currency; changes in political, economic, regulatory or environmental conditions; the loss of key customers, suppliers or members of senior management; uninsured losses; competition; credit risk associated with accounts receivable; Sarbanes-Oxley Act Section 404 compliance costs, and other risks detailed in this Quarterly Report on Form 10-Q and in any other Securities and Exchange Commission filings. The Company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise.

      On March 22, 2005, the Company announced that a Special Committee of independent directors of its Board of Directors recommended and the full Board of Directors approved an amendment to its certificate of incorporation, which, if approved by Mercury’s stockholders, would result in a one-for-501 reverse stock split of Mercury’s common stock followed by a 501-for-one forward stock split. Stockholders whose shares are converted into less than one share in the reverse split because they have fewer than 501 shares at the effective date of the reverse split would receive a cash payment from Mercury of $4.00 for each share of common stock that they held immediately prior to the reverse stock split. Stockholders who own 501 or more shares before the reverse stock split would not be affected by the transaction. The reverse/forward stock split is subject to the approval of Mercury’s stockholders. The Board would also have the discretion if and when to affect the transaction and reserves the right to abandon the transaction even if it is approved by Mercury’s stockholders.

      If the reverse/forward split is effected, Mercury would likely have fewer than 300 stockholders of record. If that is the case, Mercury would deregister its common stock under the Securities Exchange Act of 1934, Mercury’s common stock would no longer be traded on the American Stock Exchange, Mercury would no longer be required to file periodic reports with the Securities and Exchange Commission, and Mercury would no longer be required to comply with certain regulatory and reporting requirements of Sarbanes-Oxley,

including Section 404. Mercury’s future operating results and financial condition could be adversely affected in the event Mercury remains subject to these requirements of Sarbanes-Oxley. See discussion under “Government Regulation” below.

      Management believes its current capital structure and resources are adequate for current operations and, subject to the approvals and the occurrence of the other conditions referred to in the preceding paragraph, to permit the Company to effect the contemplated reverse stock split, although the cost of the reverse stock split is expected to be approximately $1.1 million. Interest rate increases or limited capital availability due to higher working capital requirements could limit capital spending or the working capital necessary to take advantage of other opportunities.

      Government Regulation — The Company is subject to the regulatory and reporting requirements of the Sarbanes-Oxley Act of 2002. Management anticipates that current and future compliance with the provisions under the Section 404 of the Act regarding annual certification of internal controls by management and attestation by the Company’s independent auditors will result in significant increases in consulting, audit and legal fees and overhead expenses related to software, documentation, testing, remediation, system enhancements, hiring new personnel and administrative time. The total cost of the Company’s compliance with the requirements of the Sarbanes-Oxley Act is uncertain, although the most costly provisions will be related to the Company’s first Section 404 compliance year ending June 30, 2007. However, management estimates such compliance costs could exceed $2.5 million through the year ending June 30, 2007. Management further believes that significant, additional costs will be incurred for each succeeding year thereafter. Such compliance cost estimates are incremental to current general and administrative expenses and do not include the opportunity costs associated with the time and effort of current employees and management, which is expected to be significant.

      Results of Operations — Comparison of the three month periods ended March 31, 2005 and March 31, 2004 and comparison of the nine month periods ended March 31, 2005 and March 31, 2004.

      The following tables set forth, for the periods indicated, the revenues and gross margin for each of the Company’s three operating units included in continuing operations, as well as selected other financial statement data.

Three Months Ended March 31, 2005 Compared to March 31, 2004

      The Company reported a loss from continuing operations of $1,871 thousand or $0.62 per basic and diluted share in the third quarter of fiscal 2005, as compared to a loss from continuing operations reported for the same period last year of $1,168 thousand, or $0.41 per basic and diluted share. For the third quarter of fiscal 2005, the Company reported a net loss of $1,871 thousand, or $0.62 per basic and diluted share. For the third quarter of fiscal 2004, the Company reported a net loss of $1,819 thousand, or $0.63 per basic and diluted share, which included a loss from discontinued operations of $651 thousand, or $0.22 per basic and diluted share. Revenue from continuing operations for the Company in the third quarter of fiscal 2005 was $158,259 thousand, which increased by $54,478 thousand or 52.5% from revenue from continuing operations of $103,781 thousand reported for the third quarter of fiscal 2004. Gross margin from continuing operations

increased by $1,454 thousand or 53.2% to $4,186 thousand in the third quarter of fiscal 2005 from $2,732 thousand reported in the third quarter of fiscal 2004.

      MercFuel, the Company’s aviation fuel sales business, generated revenue of $142,730 thousand in the third quarter of fiscal 2005 on sales volume of 84,622 thousand gallons, as compared to revenue of $88,305 thousand on sales volume of 72,393 thousand gallons in the third quarter of fiscal 2004. The following is a comparison of MercFuel’s sales information for the third quarter of fiscal 2005 and 2004, respectively:

      Revenue for MercFuel’s commercial segment increased $39,272 thousand in the third quarter of fiscal 2005 to $106,143 thousand on sales volume of 70,134 thousand gallons. The increased revenue for the commercial segment is due to higher average petroleum product prices resulting from concerns of oil supply disruptions due to general tension in the Middle East, from production control by OPEC and from increased worldwide demand for petroleum products due to an improving worldwide economy. MercFuel’s commercial segment’s average sales price in the third quarter of fiscal 2005 increased 37.2% over the third quarter of fiscal 2004’s average sales price. The increased average sales price in the third quarter of fiscal 2005, as compared to the third quarter of fiscal 2004, represents increased revenue of approximately $28,806 thousand. MercFuel’s commercial sales volume increased in the third quarter of fiscal 2005 to 70,134 thousand gallons, an increase of 9,491 thousand gallons, or 15.7%, from MercFuel’s third quarter of fiscal 2004’s commercial sales volume of 60,643 thousand gallons. The increased sales volume in the third quarter of fiscal 2005, as compared to the third quarter of fiscal 2004, represents increased revenue of approximately $10,466 thousand.

      Revenue for MercFuel’s corporate/fractional jet ownership segment was $36,587 thousand on sales volume of 14,488 thousand gallons in the third quarter of fiscal 2005, an increase of $15,153 thousand, or 70.7%, and 2,738 thousand gallons, or 23.3%, from the third quarter of fiscal 2004’s revenue of $21,434 thousand on sales volume of 11,750 thousand gallons. The increase in sales revenue is due to the increase in worldwide petroleum product prices, increased use of private aircraft for both business and personal travel and MercFuel’s strategic focus on this business segment. The average sales price for aviation jet fuel in the corporate/fractional jet ownership segment in the third quarter of fiscal 2005 increased 38.5% as compared to the third quarter of fiscal 2004 equating to increased revenue of approximately $10,158 thousand. The increased sales volume equates to an increase in revenue of approximately $4,995 thousand.

      MercFuel’s cost of aviation fuel was $139,018 thousand in the third quarter of fiscal 2005 which represents an increase of 62.5% from MercFuel’s cost of aviation fuel in the third quarter of fiscal 2004 of $85,572 thousand. The average cost of aviation fuel per gallon increased 39.0% in the third quarter of fiscal 2005 to $1.643 per gallon. The increase in the average cost of aviation fuel per gallon equates to an increase in the cost of aviation fuel of $38,989 thousand. The increase in the volume of aviation fuel purchased resulted in an increase in the cost of aviation fuel of $14,455 thousand. MercFuel’s operating expenses, excluding the cost of aviation fuel, were $1,302 thousand in the third quarter of fiscal 2005, an increase of $75 thousand from the third quarter of fiscal 2004’s operating expense excluding aviation fuel cost of $1,227 thousand.

      Air Cargo’s revenue was $10,000 thousand in the third quarter of fiscal 2005, an increase of $271 thousand, or 2.8%, from the third quarter of fiscal 2004 revenue of $9,729 thousand resulting in gross margin of $589 thousand in the third quarter of fiscal 2005, an increase of $529 thousand from last year’s gross margin of $60 thousand.