Attached files

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EX-32 - EXHIBIT 32 - PINNACLE AIRLINES CORPexhibit32.htm
EX-31.2 - EXHIBIT 31.2 - PINNACLE AIRLINES CORPexhibit31-2.htm
EX-31.1 - EXHIBIT 31.1 - PINNACLE AIRLINES CORPexhibit31-1.htm
EX-10.77 - CREDIT AGREEMENT - PINNACLE AIRLINES CORPexhibit10-77.htm
EX-10.78 - PURCHASE AND RELEASE AGREEMENT - PINNACLE AIRLINES CORPexhibit10-78.htm



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549


FORM 10-Q

x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2009
 
or
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from__________ to__________

Commission File Number 001-31898
PINNACLE AIRLINES CORP.
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction
of incorporation or organization)
03-0376558
(I.R.S. Employer
Identification No.)
   
1689 Nonconnah Blvd, Suite 111
Memphis, Tennessee
(Address of principal executive offices)
 
 38132
(Zip Code)


901-348-4100
(Registrant's telephone number, including area code)

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

Yes x
 
No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ¨
 
No ¨


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

Large accelerated filer ¨
Accelerated filer x
   
Non-accelerated filer ¨
Smaller reporting company ¨

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

Yes ¨
 
No x

As of October 30, 2009, 18,342,334 shares of common stock were outstanding.

 
 

 

Table of Contents
Part I. Financial Information
 
   
Item 1. Financial Statements
 
   
   
   
   
   
   
   
   
   
Part II.  Other Information
 
   
   
   
   
   
   
   
   












 
2

 

Part 1.  Financial Information

Item 1.  Financial Statements

Pinnacle Airlines Corp.
(in thousands, except per share data)

   
Three Months Ended September 30,
 
   
2009
   
2008
 
         
(Restated)
 
Operating revenues
           
Regional airline services
  $ 214,478     $ 220,242  
Other
    2,730       1,550  
Total operating revenues
    217,208       221,792  
Operating expenses
               
Salaries, wages and benefits
    55,402       56,378  
Aircraft rentals
    30,093       31,411  
Ground handling services
    21,964       21,651  
Aircraft maintenance, materials and repairs
    25,311       20,612  
Other rentals and landing fees
    17,659       19,369  
Aircraft fuel
    6,197       14,831  
Commissions and passenger related expense
    5,660       7,183  
Depreciation and amortization
    9,377       7,586  
Other
    21,749       21,692  
Impairment and aircraft retirement charges
    -       1,069  
Total operating expenses
    193,412       201,782  
                 
Operating income
    23,796       20,010  
                 
Operating income as a percentage of operating revenues
    11.0 %     9.0 %
Nonoperating (expense) income
               
Interest income
    277       1,289  
Interest expense
    (11,989 )     (12,758 )
Investment gain
    4,233       -  
Miscellaneous income, net
    101       192  
Total nonoperating expense
    (7,378 )     (11,277 )
Income before income taxes
    16,418       8,733  
Income tax expense
    (5,041 )     (2,526 )
Net income
  $ 11,377     $ 6,207  
                 
Basic earnings per share
  $ 0.63     $ 0.35  
                 
Diluted earnings per share
  $ 0.62     $ 0.35  
                 
Shares used in computing basic earnings per share
    17,970       17,867  
Shares used in computing diluted earnings per share
    18,204       17,891  

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

 
3

 

Pinnacle Airlines Corp.
Condensed Consolidated Statements of Operations (Unaudited)
(in thousands, except per share data)

   
Nine Months Ended September 30,
 
   
2009
   
2008
 
         
(Restated)
 
Operating revenues
           
Regional airline services
  $ 629,614     $ 640,414  
Other
    6,679       6,873  
Total operating revenues
    636,293       647,287  
Operating expenses
               
Salaries, wages and benefits
    167,999       165,582  
Aircraft rentals
    90,679       97,439  
Ground handling services
    70,622       72,712  
Aircraft maintenance, materials and repairs
    74,800       66,261  
Other rentals and landing fees
    53,987       52,123  
Aircraft fuel
    15,968       41,603  
Commissions and passenger related expense
    15,714       21,438  
Depreciation and amortization
    26,740       18,566  
Other
    54,890       68,614  
Impairment and aircraft retirement charges
    1,980       13,688  
Total operating expenses
    573,379       618,026  
                 
Operating income
    62,914       29,261  
                 
Operating income as a percentage of operating revenues
    9.9 %     4.5 %
Nonoperating (expense) income
               
Interest income
    1,942       5,326  
Interest expense
    (34,712 )     (31,194 )
Investment gain (loss)
    3,944       (8,675 )
Miscellaneous income, net
    445       166  
Total nonoperating expense
    (28,381 )     (34,377 )
Income (loss) before income taxes
    34,533       (5,116 )
Income tax benefit (expense)
    1,680       (355 )
Net income (loss)
  $ 36,213     $ (5,471 )
                 
Basic earnings (loss) per share
  $ 2.02     $ (0.31 )
                 
Diluted earnings (loss) per share
  $ 2.01     $ (0.31 )
                 
Shares used in computing basic earnings (loss) per share
    17,968       17,864  
Shares used in computing diluted earnings (loss) per share
    18,050       17,864  

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

 
4

 

Pinnacle Airlines Corp.
(in thousands, except share data)
             
   
September 30, 2009
   
December 31, 2008
 
Assets    (Unaudited)      (Restated)  
Current assets
           
Cash and cash equivalents
  $ 81,211     $ 69,469  
Restricted cash
    4,158       5,417  
Receivables, net
    33,486       31,619  
Spare parts and supplies, net
    18,570       17,106  
Prepaid expenses and other assets
    6,157       8,160  
Assets held for sale
    1,020       2,786  
Deferred income taxes, net of allowance
    10,058       13,908  
Income taxes receivable
    34,186       31,117  
Total current assets
    188,846       179,582  
Property and equipment
               
Flight equipment
    754,274       721,499  
Aircraft pre-delivery payments
    10,022       5,721  
Other property and equipment
    47,336       46,218  
Less accumulated depreciation
    (77,954 )     (53,507 )
Net property and equipment
    733,678       719,931  
                 
Investments
    4,078       116,900  
Deferred income taxes, net of allowance
    -       40,847  
Other assets
    319,726       33,724  
Debt issuance costs, net
    3,737       3,711  
Goodwill
    18,422       18,422  
Intangible assets, net
    12,784       14,585  
Total assets
  $ 1,281,271     $ 1,127,702  
                 
Liabilities and stockholders’ equity
               
Current liabilities
               
Current maturities of long-term debt
  $ 35,918     $ 32,116  
Bank line of credit
    -       8,275  
Senior convertible notes
    29,853       10,754  
Pre-delivery payment facility
    -       4,075  
Accounts payable
    20,748       30,431  
Deferred revenue
    24,363       23,851  
Accrued expenses and other current liabilities
    59,131       74,669  
Total current liabilities
    170,013       184,171  
                 
Senior convertible notes
    -       97,683  
Noncurrent pre-delivery payment facility
    4,910       -  
Long-term debt, less current maturities
    529,045       502,741  
Credit facility
    -       90,000  
Deferred revenue, net of current portion
    182,464       192,191  
Deferred income taxes, net of allowance
    4,191       -  
Other liabilities
    295,214       5,182  
                 
Commitments and contingencies
               
Stockholders’ equity
               
     Common stock, $0.01 par value; 40,000,000 shares authorized;
22,792,426 and 22,514,782 shares issued, respectively
    228       225  
     Treasury stock, at cost, 4,450,092 shares
    (68,152 )     (68,152 )
     Additional paid-in capital
    120,838       119,610  
     Accumulated other comprehensive loss
    (14,916 )     (17,172 )
     Retained earnings
    57,436       21,223  
Total stockholders’ equity
    95,434       55,734  
Total liabilities and stockholders’ equity
  $ 1,281,271     $ 1,127,702  

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

 
5

 

Pinnacle Airlines Corp.
(in thousands)
   
Nine Months Ended September 30,
 
   
2009
   
2008
 
Operating activities
       
(Restated)
 
Net income (loss)
  $ 36,213     $ (5,471 )
Adjustments to reconcile net income to cash provided by operating activities:
               
Depreciation and amortization
    31,097       20,321  
Impairment charges
    -       10,557  
Loss on ineffective portion of derivative
    1,424       -  
Investment (gain) loss
    (3,944 )     8,675  
Interest accretion, net
    5,704       7,162  
Gain on debt extinguishment
    (1,963 )     -  
Excess of insurance proceeds over cost basis of aircraft
    (842 )     -  
Deferred income taxes
    47,694       26,421  
Recognition of deferred revenue
    (17,400 )     (18,668 )
Other
    7,197       9,730  
Changes in operating assets and liabilities:
               
Restricted cash
    1,259       770  
Receivables
    (1,867 )     (2,487 )
Prepaid expenses and other assets
    (1,300 )     (1,714 )
Insurance proceeds
    3,127       1,999  
Hedge related payments
    -       (19,530 )
Spare parts and supplies
    (2,375 )     (6,249 )
Income taxes receivable
    (3,069 )     (29,336 )
Accounts payable and accrued expenses
    (5,813 )     10,418  
Change in unrecognized tax benefits and related interest
    (19,345 )     -  
Increase in deferred revenue
    8,185       1,229  
                 Cash provided by operating activities
    83,982       13,827  
Investing activities
               
Purchases of property and equipment
    (7,021 )     (25,854 )
Insurance proceeds related to property and equipment
    3,576       -  
Proceeds from sales of property and equipment
    -       142  
Purchases of auction rate securities
    -       (82,200 )
Proceeds from auction rate securities redemptions and sales
    27,770       133,450  
                  Cash provided by investing activities
    24,325       25,538  
Financing activities
               
Proceeds from debt
    24,761       91,810  
Payments on credit facilities
    (12,875 )     (59,415 )
Repurchase of senior convertible notes
    (83,870 )     -  
Payments on other long-term debt
    (23,358 )     (11,707 )
Purchase of Series A Preferred Share
    -       (20,000 )
Other financing activities
    (1,223 )     (3,009 )
                 Cash used in financing activities
    (96,565 )     (2,321 )
Net increase in cash and cash equivalents
    11,742       37,044  
Cash and cash equivalents at beginning of period
    69,469       26,785  
Cash and cash equivalents at end of period
  $ 81,211     $ 63,829  
Noncash investing and financing activities
               
 Property and equipment acquired through the issuance of debt
  $ 49,511     $ 404,098  
 Debt retired with insurance proceeds
    15,424       -  
 Debt retired with auction rate securities proceeds
    90,000       -  


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

 
6

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)





Pinnacle Airlines Corp. and its wholly owned subsidiaries, Pinnacle Airlines, Inc. and Colgan Air, Inc., are collectively referred to in this report as the “Company,” except as otherwise noted.  The Company’s subsidiaries will be referred to as “Pinnacle” for Pinnacle Airlines, Inc. and “Colgan” for Colgan Air, Inc.

Pinnacle operates an all-regional jet fleet providing regional airline capacity to Delta Air Lines, Inc. and its subsidiaries (“Delta”) at its hub airports in Atlanta, Detroit, Memphis, and Minneapolis/St. Paul.  At September 30, 2009, Pinnacle operated 126 Canadair Regional Jet (“CRJ”)-200 aircraft under Delta brands with approximately 650 daily departures to 108 cities in 31 states, the District of Columbia and three Canadian provinces.  Pinnacle also operated a fleet of 16 CRJ-900 aircraft as a Delta Connection carrier with approximately 85 daily departures to 27 cities in 15 states, the District of Columbia, Belize, Mexico, Turks and Caicos Islands, and the U.S. Virgin Islands.

Colgan operates an all-turboprop fleet under a regional airline capacity purchase agreement with Continental Airlines, Inc. (“Continental”), and also under revenue pro-rate agreements with Continental, United Air Lines, Inc. (“United”) and US Airways Group, Inc. (“US Airways”).  As of September 30, 2009, Colgan operated a fleet of 14 Q400 aircraft under a capacity purchase agreement with Continental, providing 92 daily departures to 15 cities in 11 states, the District of Columbia and one Canadian province. Colgan also operated 34 Saab aircraft under its pro-rate operations with approximately 243 daily departures to 43 destinations in ten states and the District of Columbia.

These interim financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States, the instructions to Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X, and should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (including normal recurring adjustments) necessary to present fairly the Company's financial position, the results of its operations and its cash flows for the periods indicated.  Operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ended December 31, 2009.

All amounts contained in the notes to the condensed consolidated financial statements are presented in thousands, with the exception of years, per share amounts and number of aircraft.  Certain reclassifications have been made to conform prior year financial information to the current period presentation.  In addition, certain prior period amounts have been restated to conform to the provisions of a newly adopted accounting standard that affected the accounting treatment of the Company’s senior convertible notes.  See Note 4 for further discussion of this standard.

Effective June 15, 2009, the Company adopted a new accounting standard related to subsequent events.  This standard established standards for accounting for and disclosing subsequent events (events that occur after the balance sheet date, but before financial statements are issued or are available to be issued).  Entities must now disclose the date subsequent events were evaluated and whether that evaluation took place on the date financial statements were issued or were available to be issued.  The adoption of this standard did not have a material impact on the Company’s statement of operations or balance sheet.  For the three months ended September 30, 2009, the Company has considered subsequent events through November 3, 2009, which is the date its condensed consolidated financial statements were filed with the Securities and Exchange Commission on Form 10-Q.

 
7

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)



As discussed in greater detail in Note 4, in 2005, the Company issued $121,000 of its 3.25% senior convertible notes (“the Notes”).  Holders of the outstanding Notes can require the Company to repurchase the Notes on February 15, 2010 (the “Put Date”) for a cash payment equal to the then outstanding par amount, plus accrued interest.
 
Throughout 2009, the Company has undertaken a number of initiatives to increase liquidity and reduce the amount of Notes outstanding in advance of the Put Date.  During the third quarter of 2009, the Company completed a $25,000, three-year term loan secured by its pool of spare rotable and expendable aircraft parts and certain spare engines (the “Spare Parts Loan”).  In addition, the Company reached an agreement to sell its portfolio of auction rate securities (“ARS”) to the financial institution that originally sold the ARS portfolio to the Company (the “ARS Settlement”).  After repayment of a related credit facility, the Company received approximately $27,000 in net cash proceeds from this transaction.

Throughout 2009, the Company used the proceeds from these transactions and its existing cash balances to repurchase $90,021 par amount of the outstanding Notes.  Currently, $30,979 par amount of the Notes remains outstanding.

As of September 30, 2009, the Company had $81,211 of unrestricted cash and cash equivalents.  In addition, the Company expects to receive a federal income tax refund of approximately $40,000 during the first half of 2010.  Management believes that the Company’s unrestricted cash and cash equivalents, combined with its expected operating cash flow through February 2010, will be adequate to repurchase the remaining balance of $30,979 par amount of the Notes if the Note holders exercise their options.  However, the Company is subject to minimum cash balances in some of its financing agreements, including a required month-end minimum unrestricted cash balance related to the Spare Parts Loan.  The minimum liquidity amount required in January and February 2010 is $30,000.  In addition, most of the Company’s long-term debt obligations contain cross-default provisions.  The Company may not meet its minimum unrestricted cash balance requirements after repurchase of the remaining outstanding Notes in February 2010 until it receives its federal income tax refund.  Management is in discussions with several parties about the possibility of a short-term credit facility that would be repaid upon receipt of the Company’s federal income tax refund.  If the Company is not able to complete a short-term credit facility, then it would seek a waiver of the minimum cash requirement with its lender; however, no assurance can be given at this time that such a waiver can be obtained.

For additional information regarding the Company’s liquidity, please refer to Management’s Discussion and Analysis included in Item 2 of this Form 10-Q.


The Company’s operating contracts fall under two categories: capacity purchase agreements and revenue pro-rate agreements.  The following is a summary of the percentage of regional airline services revenue attributable to each contract type and code-share partner for the three and nine months ended September 30, 2009.

   
Three Months Ended September 30, 2009
   
Percentage of Regional Airline Services Revenue
Source of Revenue
 
Capacity Purchase
Agreements
 
Pro-Rate
Agreements
 
Total
Delta
 
71%
 
-
 
71%
Continental
 
  9%
 
 6%
 
15%
US Airways
 
-
 
 6%
 
6%
United
 
-
 
 6%
 
6%
Essential Air Service
 
-
 
 2%
 
2%
     Total
 
80%
 
20%
 
100%


 
8

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


3.  Code-Share Agreements with Partners (continued)

   
Nine Months Ended September 30, 2009
   
Percentage of Regional Airline Services Revenue
Source of Revenue
 
Capacity Purchase
 Agreements
 
Pro-Rate
Agreements
 
Total
Delta
 
73%
 
-
 
73%
Continental
 
  9%
 
6%
 
15%
US Airways
 
-
 
5%
 
5%
United
 
-
 
5%
 
5%
Essential Air Service
 
-
 
2%
 
2%
     Total
 
82%
 
18%
 
100%

Recent Developments

In January 2009, the Company amended its capacity purchase agreement with Continental to operate an additional 15 Q400 aircraft, beginning in September 2010.  These additional aircraft have scheduled delivery dates from August 2010 through April 2011.

In June 2009, the Company amended its CRJ-200 airline services agreement with Delta (the “CRJ-200 ASA”) to increase the size of its CRJ-200 operating fleet by two aircraft.  These two aircraft will not be scheduled for regular service.  Instead, they will be used as spare aircraft to increase the efficiency of the Company’s CRJ-200 operations.  The Company does not expect this fleet addition to have a material effect on its results of operations.


Senior Convertible Notes

In February 2005, the Company completed the private placement of $121,000 principal amount of 3.25% senior convertible notes due February 15, 2025 (the "Notes"), of which $30,979 par amount remains outstanding as of September 30, 2009.  If certain conditions are met, the Notes are convertible into a combination of cash and common stock equivalent to the value of 75.6475 shares of the Company’s common stock per $1 par amount of Notes, or a conversion price of $13.22 per share.

Beginning on February 15, 2010 the Company may redeem the Notes for cash, in whole or in part at any time or from time to time.  The Company will give not less than 30 days’ or more than 60 days’ notice of redemption by mail to holders of the Notes.  If the Company elects to redeem the Notes, it will pay a redemption price equal to 100% of the principal amount of the Notes to be redeemed, plus accrued interest to the redemption date. The holders of the Notes may require the Company to purchase all or a portion of their Notes for cash on February 15, 2010, February 15, 2015 and February 15, 2020 at a purchase price equal to 100% of their principal amount plus accrued interest, if any.  As a result, the entire remaining obligation is shown as a current liability in the Company’s condensed consolidated balance sheet as of September 30, 2009.

New Accounting Standard

A new accounting standard related to convertible debt became effective for and was adopted by the Company beginning January 1, 2009.  This standard changed the accounting for convertible debt instruments that may be settled in cash (including partial cash settlement) upon conversion.  Issuers must account separately for the liability and equity components of certain convertible debt instruments in a manner that reflects the issuer's nonconvertible debt (unsecured debt) borrowing rate when interest cost is recognized.  In addition, issuers are required to bifurcate the value of the convertible instrument upon its issuance into the component that represented debt and the component that represented the imbedded equity option.  The value of the imbedded equity option is reclassified to additional paid-in capital.  The resulting discount on the par amount of the debt is recognized as interest expense in the Company’s consolidated statement of operations over the expected term of the debt.

 
9

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


4.  Borrowings (continued)

The new accounting standard requires retrospective application to the terms of instruments as they existed for all periods presented.  The cumulative effect of the changes in accounting principle on periods prior to those presented is recognized as of the beginning of the first period presented with an offsetting adjustment made to the opening balance of retained earnings for that period.  As a result, the Company recorded a net $12,565 reduction to the January 1, 2008 balance of retained earnings to apply the provisions of the new standard from the February 15, 2005 issuance date of the Notes.

The Company estimated the fair value of the Notes as of the date of issuance.  The difference between the fair value and the principal amounts of the Notes was $44,046.  This amount was retrospectively applied to the Company’s financial statements from the issuance date, and was retrospectively recorded as a debt discount and as an increase to additional paid-in capital, net of tax.  The discount is being amortized over the expected five-year life of the Notes resulting in an increase to interest expense in historical and future periods. The following reconciles the Company’s consolidated statements of operations for the three and nine months ended September 30, 2008 and its condensed consolidated balance sheet as of December 31, 2008, as originally reported to the restated statements contained in these financial statements.

   
Three Months Ended September 30, 2008
 
   
As Reported
   
Adjustments
   
Restated
 
Operating income
  $ 20,010     $ -     $ 20,010  
                         
Nonoperating (expense) income
                       
Interest income
    1,289       -       1,289  
Interest expense
    (10,253 )     (2,505 )     (12,758 )
Miscellaneous income
    192       -       192  
Total nonoperating expense
    (8,772 )     (2,505 )     (11,277 )
Income before income taxes
    11,238       (2,505 )     8,733  
Income tax (expense) benefit
    (3,521 )     995       (2,526 )
Net income
  $ 7,717     $ (1,510 )   $ 6,207  
                         
Basic and diluted income per share
  $ 0.43     $ (0.08 )   $ 0.35  

   
Nine Months Ended September 30, 2008
 
   
As Reported
   
Adjustments
   
Restated
 
Operating income
  $ 29,261     $ -     $ 29,261  
                         
Nonoperating (expense) income
                       
Interest income
    5,326       -       5,326  
Interest expense
    (23,915 )     (7,279 )     (31,194 )
Net investment loss
    (8,675 )     -       (8,675 )
Miscellaneous income
    166       -       166  
Total nonoperating expense
    (27,098 )     (7,279 )     (34,377 )
Income (loss) before income taxes
    2,163       (7,279 )     (5,116 )
Income tax (expense) benefit
    (3,244 )     2,889       (355 )
Net loss
  $ (1,081 )   $ (4,390 )   $ (5,471 )
                         
Basic and diluted loss per share
  $ (0.06 )   $ (0.25 )   $ (0.31 )


 
10

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


4.  Borrowings (continued)

   
As of December 31, 2008
 
   
As Reported
   
Adjustments
   
Restated
 
Current deferred tax asset
  $ 14,338     $ (430 )   $ 13,908  
Total current assets
    180,012       (430 )     179,582  
 
Net property and equipment
    717,970       1,961       719,931  
Noncurrent deferred tax asset
    45,004       (4,157 )     40,847  
Debt issuance costs, net
    6,505       (2,794 )     3,711  
Total assets
    1,133,122       (5,420 )     1,127,702  
Senior convertible notes
    121,000       (12,563 )     108,437  
 
Additional paid-in capital
    93,812       25,798       119,610  
Retained earnings
    39,878       (18,655 )     21,223  
Total liabilities and stockholders’ equity
  $ 1,133,122     $ (5,420 )   $ 1,127,702  

In January 2009, the Company repurchased $12,000 par value of the Notes for $8,870 plus accrued and unpaid interest.  The book value of that portion of the Notes at the time of the repurchase was $10,801.  As a result, the Company recorded a gain on debt extinguishment of $1,931 during the three months ended March 31, 2009.

In August 2009, the Company repurchased $78,021 par value of the Notes for $75,000 plus accrued and unpaid interest.  The book value of that portion of the Notes at the time of the repurchase was $74,492.  As a result, the Company recorded a gain on debt extinguishment of $115 and a reduction to additional paid-in capital of $523, net of tax, during the three months ended September 30, 2009.

As a result of the adoption of the new accounting standard, interest expense increased by $1,898 and $6,952 for the three and nine months ended September 30, 2009.  Income before income taxes, net income and EPS decreased by $1,898, $1,147, and $0.06, respectively, for the three months ended September 30, 2009, and by $6,952, $4,202, and $0.23, respectively, for the nine months ended September 30, 2009.

The unamortized discount of the liability component was $1,127 and $12,563 at September 30, 2009 and December 31, 2008, respectively.  This discount will be amortized through February 15, 2010.  The fair value of the Notes as of September 30, 2009 and December 31, 2008 was $29,623 and $80,465, respectively.

The following table provides additional information about the Company’s Notes:

 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
 
2009
   
2008
   
2009
   
2008
 
Effective interest rate on liability component
  13.5 %     13.5 %     13.5 %     13.5 %
Interest cost recognized as amortization of the discount of
   liability component
 $ 1,841      $ 2,466      $ 6,708      $ 7,162  
Cash interest cost recognized (coupon interest)
 $ 662      $ 983      $ 2,440      $ 2,949  


 
11

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


4.  Borrowings (continued)

Credit Facility

In March 2008, the Company entered into a revolving term loan (the “Credit Facility”) with a financial institution.  The Credit Facility provided for advances up to $60,000 and was collateralized by the Company’s ARS portfolio. The Company amended the Credit Facility in June 2008, to increase the eligible amount for borrowing from $60,000 to $80,000, and again in November 2008 to increase the eligible amount for borrowing from $80,000 to $90,000.  The agreement allowed up to $80,000 of the proceeds to be used to support the Company’s aircraft purchases and for general working capital purposes.  The remaining $10,000 was restricted for use to retire other outstanding debt, which the Company used to repurchase $12,000 par value of the Notes in January 2009 and to repay a portion of its pre-delivery deposit financing facility as aircraft delivered in December 2008.

During the three months ended September 30, 2009, the Company repaid in full the Credit Facility as a result of the ARS Settlement.  See Note 10 for further discussion.

Line of Credit

The Company maintained a revolving line of credit with an institutional lender for a principal amount not to exceed $8,500 or 75% of the net unpaid balance of Colgan’s eligible accounts receivable.  Amounts outstanding under this line of credit were $8,275 at December 31, 2008.  This instrument had an interest rate of Prime plus 0.25%, which was 3.50% as of December 31, 2008.  The line of credit expired on April 15, 2009, and the outstanding balance was paid in full.

Long-Term Notes Payable

As of September 30, 2009 and December 31, 2008, the Company had long-term notes payable of $564,963 and $534,857, respectively.  Included in long-term notes payable are borrowings from Export Development Canada (“EDC”) for owned aircraft.  The borrowings are collateralized by the Company’s fleet of CRJ-900 and Q400 aircraft and bear interest at rates ranging between 3.8% and 6.7% with maturities through the fourth quarter of 2023.  Amounts outstanding under these EDC borrowings were $522,276 and $512,575 at September 30, 2009 and December 31, 2008, respectively.

The fair value of the Company’s long-term notes payable as of September 30, 2009 and December 31, 2008 was $477,274 and $435,949, respectively.  These estimates were based on either market prices or the discounted amount of future cash flows using the Company’s current incremental rate of borrowing for similar liabilities.

As discussed in Note 11, one of the Company’s Q400 aircraft was destroyed in an accident on February 12, 2009.  The insurance proceeds were used to retire the related debt of approximately $15,400 during the three months ended March 31, 2009.

As previously discussed, on January 13, 2009, the Company amended its Continental CPA to operate an additional 15 Q400 aircraft beginning in September 2010.  The aircraft have scheduled delivery dates from August 2010 through April 2011.  In connection with this amendment, the Company executed a new pre-delivery payment financing facility with EDC for up to $35,600 on substantially similar terms to its other pre-delivery payment facilities.  This instrument has an interest rate indexed to LIBOR, which was 3.43% as of September 30, 2009.  Amounts outstanding under this facility were $4,910 at September 30, 2009, and were classified as long-term.

 
12

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


4.  Borrowings (continued)

Spare Parts Loan

On July 30, 2009, the Company completed a $25,000, three-year term loan financing with C.I.T. Leasing and funded by CIT Bank.  The Spare Parts Loan is secured by the Company’s pool of spare repairable, rotable and expendable parts and certain aircraft engines.  The interest rate for the Spare Parts Loan is a variable rate, which for the first interest period is indexed to LIBOR (subject to a floor) and was 8.5% as of September 30, 2009. The Spare Parts Loan requires that the Company maintain a minimum liquidity level at the end of every month and at specified times preceding the maturity date or call date of certain other indebtedness. The Spare Parts Loan also has standard provisions relating to the Company’s obligation to timely repay the indebtedness and maintenance of the collateral base relative to the outstanding principal amount of the borrowing.  The proceeds of the Spare Parts Loan were used to repurchase a portion of the Notes during the three months ended September 30, 2009.  Amounts outstanding under the Spare Parts Loan were $24,684 as of September 30, 2009.


As of September 30, 2009 and December 31, 2008, the Company had no outstanding interest rate derivatives.  The tables below present the effect of the Company’s derivative financial instruments on the condensed consolidated statements of operations for the three and nine months ended September 30, 2009 and 2008:

Three Months Ended
September 30,
 
Amount of Loss Reclassified
from OCI into Income
(Effective Portion) (2)
   
Amount of Loss Recognized
in Income on Derivative (Ineffective
Portion and Amount Excluded from
Effectiveness Testing)
 
2009
  $ (774 )   $ -  
2008
  $ (734 )   $ -  

Nine Months Ended
September 30,
 
Amount of Loss Reclassified
from OCI into Income
(Effective Portion) (2)
   
Amount of Loss Recognized
in Income on Derivative (Ineffective
Portion and Amount Excluded from
Effectiveness Testing)
 
2009
  $ (2,372 )   $ (1,424 )(1)
2008
  $ (1,518 )   $  -  

(1)
This charge is related to the debt that financed the Q400 aircraft that was destroyed in an accident during the three months ended March 31, 2009.  The associated debt was repaid during the first quarter of 2009.  This loss is included in miscellaneous nonoperating expense in the Company’s condensed consolidated statement of operations for the nine months ended September 30, 2009.
(2)
Derivatives classified as cash flow hedges include interest rate swaps.  Amounts reclassified from OCI into income are recorded in interest expense within the Company’s condensed consolidated statements of operations.

The losses from settled interest rates swaps recorded in other comprehensive income (“OCI”), net of tax and amortization, within the condensed consolidated balance sheets were $15,347 and $17,752 as of September 30, 2009 and December 31, 2008, respectively.  Included in the above total net realized losses from interest rate swaps as of September 30, 2009, are $3,004 in net unrecognized losses that are expected to be amortized into earnings during the 12 months following September 30, 2009.

 
13

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)



The components of comprehensive income (loss), net of related taxes, for the three and nine months ended September 30, 2009 and 2008 are as follows:
 
 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
 
2009
   
2008
   
2009
   
2008
 
       
(Restated)
         
(Restated)
 
Net income (loss)
$ 11,377     $ 6,207     $ 36,213     $ (5,471 )
Adjustments:
                             
Retired Pilots’ Insurance Benefit Plan unrealized actuarial gain
  (136 )     (6 )     (149 )     (59 )
Change in cash flow hedge unrealized loss
  494       230       2,405       (5,591 )
Reversal of unrealized gain on investments
  (4,404 )     -       -       -  
Total comprehensive income (loss)
$ 7,331     $ 6,431     $ 38,469     $ (11,121 )


The following table sets forth the computation of basic and diluted earnings per share:

 
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
 
2009
   
2008
   
2009
   
2008
 
       
(Restated)
         
(Restated)
 
Net income (loss)
$ 11,377     $ 6,207     $ 36,213     $ (5,471 )
Basic earnings (loss) per share
$ 0.63     $ 0.35     $ 2.02     $ (0.31 )
Diluted earnings (loss) per share
$ 0.62     $ 0.35     $ 2.01     $ (0.31 )
                               
Share computation:
                             
Weighted average number of shares outstanding for basic earnings per share
  17,970       17,867       17,968       17,864  
Senior convertible notes
  -       -       -       -  
Share-based compensation (1)
  234       24       82       -  
Weighted average number of shares outstanding for diluted earnings per share
  18,204       17,891       18,050       17,864  

(1)
During the three months ended September 30, 2009 and 2008 options to acquire 1,094 and 1,119 shares, respectively, were excluded from the computation of diluted EPS as their impact was anti-dilutive. During the nine months ended September 30, 2009 and 2008 options to acquire 1,684 and 920 shares, respectively, were excluded from the computation of diluted EPS as their impact was anti-dilutive.


In January 2009, the Company granted 626 stock options with an exercise price of $2.65 per share to members of its Board of Directors, its officers and certain other employees.  These grants will vest ratably over three years.  Total expense to be recognized over the vesting period, net of expected annual forfeitures of 4%, is $834. The following table presents the assumptions used and fair value for the 2009 equity grant:

 
14

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


8.  Share-Based Compensation  (continued)

     
2009
Expected price volatility
   
58.3%
Risk-free interest rate
   
1.4%
Expected lives (years)
   
5.0
Dividend yield
   
 0.0%
Expected annual forfeiture rate
   
 4.0%
Exercise price of option grants
   
$2.65
Fair value of option grants
   
$1.33

In January 2009, the Company awarded 278 shares of restricted stock to certain officers and members of the Board of Directors.  Using the straight-line method, the fair value of $738 is being expensed ratably over the three-year vesting period.  The grant date fair value of these shares was $2.65 per share, which was the closing stock price on the date of grant.

During the three and nine months ended September 30, 2009, the Company recognized $586 and $1,948, respectively, of share-based compensation expense, and $616 and $1,989, respectively, for the same periods of the prior year.

The following table provides certain information with respect to the Company’s stock options:

   
Stock Options
   
Shares
   
Weighted
Average
Exercise Price
 
Weighted
Average
Remaining Life
 
Aggregate
Intrinsic
Value
Outstanding at January 1, 2009
    1,106     $ 13.09        
Granted
    626       2.65        
Exercised
    -       -        
Expired
    (8 )     11.70        
Forfeited
    (11 )     7.11        
Outstanding at September 30, 2009
    1,713     $ 9.32  
 7.2 years
  $ 2,553
Options exercisable at September 30, 2009
    857     $ 12.58  
5.5 years
  $ 47

The following table provides certain information with respect to the Company’s restricted stock:

   
Restricted Stock
   
Shares
   
Fair Value
Unvested at January 1, 2009
    197     $ 2,599
Granted
    278       738
Vested
    (102 )     (1,186)
Forfeited
    -       -
Unvested at September 30, 2009
    373     $ 2,151


During the three months ended March 31, 2009, the Company reached agreement with the Internal Revenue Service (the “Service”) to resolve certain matters related to the Service’s examination of the Company’s federal income tax returns for calendar years 2003, 2004 and 2005.  Previously, the Service had proposed a number of adjustments to the Company’s returns totaling approximately $35,000 of additional tax, plus accrued interest and penalties on these proposed adjustments.

 
15

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


9. Income Taxes (continued)

The Company and the Service agreed for the Company to pay approximately $3,000 of additional income tax and accrued interest in settlement of all open tax matters for these years.  With this agreement, the Service completed its examination of the Company’s federal tax filings for 2003, 2004 and 2005.  The Company paid the settlement amount during the three months ended June 30, 2009.  As a result of the completion of this examination, the Company recorded during the three months ended March 31, 2009 a reduction to income tax expense of $13,551 and a pre-tax reduction to interest expense of $2,926.

The following summarizes the significant components of the Company’s income tax expense for the periods indicated:
 
   
Three Months Ended September 30,
 
   
2009
   
2008 (Restated)
 
   
Dollars
   
Percent
   
Dollars
   
Percent
 
Income tax expense at statutory rate
  $ (5,746 )     (35.0 )%   $ (3,057 )     (35.0 )%
State income taxes, net of federal taxes
    (534 )     (3.2 )%     (789 )     (9.0 )%
Settlements
    -       -       -       -  
Tax-exempt income
    71       0.4 %     2,145       24.6 %
Meals and entertainment
    (146 )     (0.9 )%     (733 )     (8.4 )%
Valuation allowance
    1,248       7.6 %     -       -  
Other
    66       0.4 %     (92 )     (1.1 )%
Income tax expense
  $ (5,041 )     (30.7 )%   $ (2,526 )     (28.9 )%

   
Nine Months Ended September 30,
 
   
2009
   
2008 (Restated)
 
   
Dollars
   
Percent
   
Dollars
   
Percent
 
Income tax (expense) benefit at statutory rate
  $ (12,087 )     (35.0 )%   $ 1,791       (35.0 )%
State income taxes, net of federal taxes
    (816 )     (2.4 )%     (484 )     9.5 %
Settlements
    13,401       38.8 %     -       -  
Tax-exempt income
    290       0.9 %     3,394       (66.3 )%
Meals and entertainment
    (391 )     (1.1 )%     (1,110 )     21.7 %
Valuation allowance
    1,377       4.0 %     (3,036 )     59.3 %
Other
    (94 )     (0.3 )%     (910 )     17.7 %
Income tax benefit (expense)
  $ 1,680       4.9 %   $ (355 )     6.9 %

The Company provides for interest and penalties accrued related to unrecognized tax benefits in nonoperating expenses.  As of September 30, 2009 and December 31, 2008, the Company had $317 and $3,692 of accrued interest and penalties, respectively.

The following table reconciles the Company’s beginning and ending unrecognized tax benefits balances:

   
2009
 
Unrecognized tax benefits balance at January 1
  $ 16,518  
Increases (decreases) for prior period positions
    (1,525 )
Increases (decreases) for current period positions
    -  
Settlements
    (14,446 )
Lapses of statutes
    -  
Unrecognized tax benefits balance at September 30
  $ 547  

The amount of unrecognized tax benefits that would affect the Company’s effective tax rate if recognized was $547 as of September 30, 2009.  

 
16

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)



The Company invests excess cash balances primarily in short-term money market instruments.  Investments in marketable securities are classified as available-for-sale and presented at their estimated fair values based on quoted market prices for those securities.

The Company’s investment portfolio previously consisted primarily of ARS.  As discussed in Note 2, on August 24, 2009, the Company entered into the ARS Settlement, whereby a financial institution purchased the ARS from the Company at a discount to par plus accrued interest, and the Company utilized a portion of the purchase price of the ARS to repay all amounts outstanding under the Credit Facility.  In addition, the ARS Settlement provides that for a period of three years from the date of the ARS Settlement, the Company shall have the right to repurchase all or a portion of the ARS at the same discount to par the bank paid to the Company under the ARS Settlement (the “ARS Call Options”).  The Company determined the fair value of the ARS Call Options to be $4,078 at September 30, 2009.  They are classified as investments on the Company’s condensed consolidated balance sheet as of September 30, 2009.

Fair Value Measurements
 
The Company’s borrowings and investments are required to be measured at fair value on a recurring basis.  Due to events in the credit markets that predominantly began during the first quarter of 2008, there is no longer an active trading market for ARS.  Therefore, the fair values of the Company’s ARS were estimated utilizing a discounted cash flow model.  This model considered, among other items, the collateralization underlying the investments, the creditworthiness of the counterparty, the timing of expected future cash flows, and an estimate of when the security is expected to have a successful auction or be called by the issuer.  These securities were also compared, when possible, to other observable market data with similar characteristics to the securities held by the Company.  As previously discussed, the Company’s balance of ARS as of September 30, 2009 was $0.
 
The fair values of the ARS Call Options were also estimated using a discounted cash flow model.  The model considered potential changes in yields for securities with similar characteristics to the underlying ARS and evaluated possible future refinancing opportunities for the issuers of the ARS.  The analysis then assessed the likelihood that the options would be exercisable as a result of the underlying ARS being redeemed or traded in a secondary market at an amount greater than the exercise price prior to the end of the option term.  Future changes in the fair values of the ARS Call Options will be marked to market through the statement of operations. 
 
The tables below present the Company’s assets and liabilities measured at fair value as of September 30, 2009, aggregated by the level in the fair value hierarchy within which those measurements fall.
 
 
Level 1
   
Level 2
   
Level 3
   
Balance at
September 30, 2009
Assets
                   
Investments in ARS
$ -     $ -     $ -     $ -
ARS Call Options
$ -     $ -     $ 4,078     $ 4,078

 

 
17

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


10. Investments and Fair Value Measurements (continued)

 
The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3):
 
   
Asset
 
   
Auction Rate Securities
 
   
Nine Months Ended September 30,
 
   
2009
   
2008
 
Balance at beginning of period
  $ 116,900     $ -  
Transfers to Level 3
    -       136,100  
Total unrealized gains (losses)
               
    Included in nonoperating expense
    -       -  
    Included in other comprehensive income (“OCI”)
    -       (9,955 )
Realized gains on redemptions, included in nonoperating expense(1)
    44       -  
Interest accretion
    438       -  
Redemptions (2)
    (2,700 )     -  
Balance at March 31
  $ 114,682     $ 126,145  
Transfers to Level 3
    -       -  
Total unrealized gains (losses)
               
    Included in nonoperating expense
    (966 )     (8,675 )
    Included in OCI
    4,598       9,955  
Realized gains on redemptions, included in nonoperating expense(1)
    632       -  
Interest accretion
    437       -  
Redemptions (2)
    (2,950 )     -  
Balance at June 30
  $ 116,433     $ 127,425  
Transfers to Level 3
    -       -  
Total unrealized gains (losses)
               
    Included in nonoperating expense
    155       -  
    Included in OCI
    (4,598 )     -  
Interest accretion
    130       -  
Redemptions (2)
    (800 )     (500 )
Sales (3)
    (111,320 )     -  
Balance at September 30
  $ -     $ 126,925  
                 
(1) The Company determines the cost basis for ARS redemptions using the specific identification method.
 
(2)  Partial redemption of securities at par by the issuer.
               
(3) Proceeds received from the sale of the ARS portfolio in connection with the ARS Settlement.
 


 
18

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


10. Investments and Fair Value Measurements (continued)

 
Asset
 
ARS Call Options
 
Nine Months Ended September 30,
 
2009             
   
2008                 
Balance at beginning of period
$ -     $ -
Transfers to Level 3
  -       -
Balance at March 31
$ -     $ -
Transfers to Level 3
  -       -
Balance at June 30
$ -     $ -
Transfers to Level 3
  4,078       -
Total unrealized gains (losses)
           
    Included in nonoperating income
  -       -
    Included in OCI
  -       -
Balance at September 30
$ 4,078     $ -

Effective June 30, 2009, the Company adopted new accounting guidance that extends the disclosure requirements regarding fair value of financial instruments to interim financial statements.  The adoption of this standard affects disclosures only and had no effect on the Company’s statement of operations, balance sheet, or statement of cash flows.  The carrying amounts and estimated fair values of the Company’s borrowings, which are discussed in detail in Note 4, as of September 30, 2009 were as follows:

 
Carrying Amount
   
Estimated Fair Value
Senior convertible notes
$ 29,853     $ 29,623
Pre-delivery payment financing facilities
  4,910       4,910
Long-term notes payable, primarily related to owned aircraft
  564,963       434,586


Employees. The Company operates under several collective bargaining agreements with groups of its employees.  Pinnacle has been involved in active negotiations with the Air Line Pilots Association (“ALPA”) since April 2005, when the collective bargaining agreement between the two parties became amendable.  On August 4, 2009, Pinnacle and ALPA reached a tentative agreement to amend the collective bargaining agreement.  The tentative agreement contained substantial wage rate increases and a proposed $10,200 signing bonus for Pinnacle’s pilots.  However, on September 24, 2009, Pinnacle’s pilots voted against ratification of the tentative agreement.  The National Mediation Board will determine when the parties will resume negotiations.

In late 2008, Colgan’s pilot group elected representation by ALPA.  The Company and ALPA began negotiating an initial collective bargaining agreement to cover Colgan’s pilot group in September 2009.  The Company is not yet able to estimate the timing or financial impact of a new collective bargaining agreement.

Guarantees and Indemnifications.  In the Company’s aircraft lease and financing agreements, including sublease agreements with Delta, the Company typically indemnifies the primary lessor or lender, financing parties, trustees acting on their behalf and other related parties against liabilities that arise from the manufacture, design, ownership, financing, use, operation and maintenance of the aircraft and for tort liability, whether or not these liabilities arise out of or relate to the negligence of these indemnified parties, except for their gross negligence or willful misconduct.

 
19

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


11. Commitments and Contingencies (continued)

The Company is party to numerous contracts and real estate leases in which it is common for it to agree to indemnify third parties for tort liabilities that arise out of or relate to the subject matter of the contract or occupancy of the leased premises. In some cases, this indemnity extends to related liabilities arising from the negligence of the indemnified parties, but usually excludes any liabilities caused by their gross negligence or willful misconduct. Additionally, the Company typically indemnifies the lessors and related third parties for any environmental liability that arises out of or relates to its use of the leased premises.

The Company expects that its levels of insurance coverage (subject to deductibles) would be adequate to cover most tort liabilities and related indemnities described above with respect to real estate it leases and aircraft it operates.  The Company does not expect the potential amount of future payments under the foregoing indemnities and agreements to be material.

Litigation Contingencies.  Colgan is a defendant in litigation related to the September 11, 2001 terrorist attacks.  The Company expects that any adverse outcome from this litigation will be covered by insurance, and therefore, will have no material adverse effect on the Company’s financial statements as a whole.

On February 12, 2009, Colgan Flight 3407, operated for Continental under the Company’s Continental CPA, crashed in a neighborhood near the Buffalo Niagara International Airport in Buffalo, New York. All 49 people aboard, including 45 passengers and four members of the flight crew, died in the accident. Additionally, one individual died inside the home destroyed by the aircraft’s impact.  Several lawsuits related to this accident have been filed against the Company, and additional litigation is anticipated.  The Company carries aviation risk liability insurance and believes that this insurance is sufficient to cover any liability arising from this accident.

The Company has recorded a related liability of approximately $300,000 in other non-current liabilities on its condensed consolidated balance sheet at September 30, 2009 related to potential claims associated with this accident.  This liability is offset in its entirety by a corresponding long-term receivable, recorded in other assets on the condensed consolidated balance sheet that the Company expects to receive from insurance carriers as claims are resolved.  These estimates may be revised as additional information becomes available.

Disputes with Codeshare Partner.  The Company is in discussions with Delta regarding certain disputed contractual items in its CRJ-200 ASA.  Specifically, Delta has challenged a one-time adjustment to the Company’s block hour, cycle and fixed payment rates that was to become effective January 1, 2006.  The impact of Delta’s assertion could be a cumulative adjustment of as much as $11,000 from 2006 through September 30, 2009, and a rate decrease of approximately $3,000 annually until the next contractually scheduled rate adjustment on January 1, 2013. The parties have agreed to arbitrate this dispute, and the Company expects arbitration proceedings to begin shortly.

In addition, Delta has asserted that it may materially alter the payments related to the Company’s ground handling in the majority of the airports where Pinnacle operates, which would result in a decrease in Pinnacle’s 2009 operating income of approximately $1,100.  This disputed amount could change in future periods due to potential changes in the mix of cities in which Pinnacle operates.  In August 2009, Delta began to apply its interpretation of ground handling to the monthly wires that Pinnacle received, resulting in a net reduction of payments to Pinnacle of approximately $300 for August and September.  In addition, Delta asserted that Pinnacle owes Delta a retroactive payment related to this ground handling issue of approximately $4,000.   The Company believes Delta’s assertion is invalid and continues to discuss this dispute with Delta.  If the Company is unable to resolve this dispute through discussions, it may jointly seek arbitration with Delta.

 
20

 
Pinnacle Airlines Corp.
Notes to Condensed Consolidated Financial Statements
(all amounts in thousands, except per share data)


11. Commitments and Contingencies (continued)

Finally, Delta has disputed its obligation to fully reimburse Pinnacle for its aviation insurance premiums.  During the second quarter of 2009, Delta requested that Pinnacle exit the Delta aviation insurance program and independently source its own aviation insurance.  Effective July 1, 2009, Pinnacle obtained its own independent insurance program at a cost significantly higher than what it was allocated by Delta under the Delta insurance program.  Delta has asserted that it is not obligated to reimburse the full costs of Pinnacle’s independent insurance program, despite the fact that the Company believes both Pinnacle’s CRJ-200 ASA and the CRJ-900 Delta Connection Agreement require full reimbursement.  Delta has not reimbursed Pinnacle for approximately $1,700 related to the three months ended September 30, 2009.  The Company believes Delta’s assertion is without merit, and the Company is reviewing its legal options to enforce its rights under its operating contracts with Delta.


Generally accepted accounting principles require disclosures related to components of a company for which separate financial information is available to and regularly evaluated by the company’s chief operating decision maker (“CODM”) when deciding how to allocate resources and in assessing performance.

The Company’s two operating segments consist of its two subsidiaries, Pinnacle Airlines, Inc. (“Pinnacle”) and Colgan Air, Inc. (“Colgan”).   Corporate overhead costs incurred by Pinnacle Airlines Corp. are allocated to the operating costs of each subsidiary.

The following represents the Company’s segment data for the periods indicated:

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2009
   
2008
   
2009
   
2008
 
         
(restated)
         
(restated)
 
Operating revenues:
                       
    Pinnacle
  $ 155,253     $ 148,142     $ 465,177     $ 458,244  
    Colgan
    61,955       73,650       171,116       189,043  
    Consolidated
  $ 217,208     $ 221,792     $ 636,293     $ 647,287  
                                 
Operating income (loss):
                               
    Pinnacle
  $ 15,686     $ 12,016     $ 46,582     $ 39,752  
    Colgan
    8,110       7,994       16,332       (10,491 )
    Consolidated
  $ 23,796     $ 20,010     $ 62,914     $ 29,261  

The following represents the Company’s segment assets:

   
September 30, 2009
   
December 31, 2008
 
Total assets:
       
(restated)
 
    Pinnacle
  $ 610,124     $ 582,176  
    Colgan
    680,535       388,990  
    Unallocated
    (9,388 )     156,536  
    Consolidated
  $ 1,281,271     $ 1,127,702  

 
21

 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations




Certain statements in this Current Report on Form 10-Q (or otherwise made by or on the behalf of Pinnacle Airlines Corp.) contain various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and the Private Securities Litigation Reform Act of 1995.  Such statements represent management's beliefs and assumptions concerning future events. When used in this document and in documents incorporated by reference, forward-looking statements include, without limitation, statements regarding financial forecasts or projections, our expectations, beliefs, intentions or future strategies that are signified by the words "expects," "anticipates," "intends," "believes" or similar language. These forward-looking statements are subject to risks, uncertainties and assumptions that could cause our actual results and the timing of certain events to differ materially from those expressed in the forward-looking statements. All forward-looking statements included in this Report are based on information available to us on the date of this Report. It is routine for our internal projections and expectations to change as the year or each quarter in the year progress, and therefore it should be clearly understood that the internal projections, beliefs and assumptions upon which we base our expectations may change prior to the end of each quarter or the year. Although these expectations may change, we may not inform you if they do. Our policy is generally to provide our expectations only once per quarter, and not to update that information until the next quarter.

Many important factors, in addition to those discussed in this Report, could cause our results to differ materially from those expressed in the forward-looking statements. Some of the potential factors that could affect our results are described in “Overview and Outlook.”  In light of these risks and uncertainties, and others not described in this Report, the forward-looking events discussed in this Report might not occur, might occur at a different time, or might cause effects of a different magnitude or direction than presently anticipated.

General

The following management’s discussion and analysis describes the principal factors affecting the Company’s results of operations, liquidity, capital resources and contractual cash obligations.  This discussion should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and our Annual Report on Form 10-K for the year ended December 31, 2008 (“Annual Report”), which include additional information about our business practices, significant accounting policies, risk factors, and the transactions that underlie our financial results.

Our website address is www.pncl.com.  All of our filings with the SEC are available free of charge through our website as soon as reasonably practicable after we file them with, or furnish them to, the SEC.

Overview and Outlook

As with the second quarter of 2009, our results of operations improved substantially year-over-year during the third quarter of 2009.  Our consolidated operating income improved by $3.8 million as compared to the third quarter of 2008.  As more fully discussed below under “Results of Operations,” these improvements came about through, among other things, the full implementation of our new capacity purchase agreements with Delta and Continental, a significant decrease in the cost of fuel incurred by Colgan, and the restructuring of Colgan’s pro-rate operations, partially offset by a decline in unit revenue in Colgan’s pro-rate operations.  Our net income in 2009 is also substantially increased as a result of our settlement with the Internal Revenue Service related to their review of our tax filings for 2003, 2004, and 2005.  We recorded a nonrecurring increase in net income of $13.6 million from this settlement.

 

 
22

 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 
    In addition to improvements in our operating and net income, we have completed a number of transactions during 2009 to increase our liquidity in advance of the date that holders of our remaining outstanding 3.25% senior convertible notes (the “Notes”) may require us to repurchase them.  Holders of the Notes have an option on February 15, 2010 (the “Put Date”) to require us to repurchase the then outstanding Notes for the par amount plus accrued interest.  Because of this impending obligation in February 2010, we have focused on increasing our liquidity and reducing the amount of the Notes outstanding through secondary market repurchases.  During the third quarter of 2009, we completed a $25 million term loan collateralized by our pool of spare rotable and expendable inventory and certain spare engines (the “Spare Parts Loan”).  In addition, we entered into a settlement agreement (the “ARS Settlement”) with a financial institution that sold us our portfolio of auction rate securities (“ARS”).  The ARS Settlement increased our cash balance by approximately $27 million. As a result of these transactions and positive operating cash flow of $84.0 million for the first nine months of 2009, we have substantially increased our liquidity position.  We used this increase in liquidity to repurchase $12 million par amount of the Notes in the first quarter of 2009 and approximately $78 million par amount of the Notes during the third quarter of 2009.  Approximately $31 million par amount of the Notes remains outstanding as of September 30, 2009.

In addition to the initiatives outlined above, we expect to receive a federal income tax refund in the first half of 2010 totaling approximately $40 million related to our 2009 federal income tax return.  Although we likely will not receive this refund until after the Put Date on the Notes, receipt of this refund will further enhance our liquidity position.

As a result of these accomplishments, we believe we have sufficient resources to repay the remaining outstanding $31.0 million par amount of Notes on the Put Date.  However, we may not have sufficient liquidity to meet the month-end minimum unrestricted cash and cash equivalents requirements contained in some of our financing agreements (primarily the Spare Parts Loan) after the Put Date until we receive our 2009 federal income tax refund (for additional information regarding this minimum cash requirement test, please refer to Notes 2 and 4 of our condensed consolidated financial statements, which are contained in Item 1 of this Form 10-Q).  We are in discussions with several parties about the possibility of a short-term credit facility to bridge the period between the Put Date and receipt of our 2009 federal income tax refund.  To the extent we are unsuccessful in sourcing a short-term credit facility or otherwise increasing liquidity to meet our month-end minimum cash requirements, we will seek a temporary waiver of the requirement from our lender; however no assurance can be given at this time that such a waiver can be obtained.

We are in discussions with Delta regarding certain disputed contractual items in our CRJ-200 ASA.  Specifically, Delta has challenged a one-time adjustment to our block hour, cycle and fixed payment rates that was to become effective January 1, 2006.  The impact of Delta’s assertion could be a cumulative adjustment of as much as $11.0 million from 2006 through September 30, 2009, and a rate decrease of approximately $3.0 million annually until the next contractually scheduled rate adjustment on January 1, 2013. The parties have agreed to arbitrate this dispute, and we expect arbitration proceedings to begin shortly.

In addition, Delta has asserted that it may materially alter the payments related to Pinnacle’s ground handling in the majority of the airports where Pinnacle operates, which would result in a decrease of Pinnacle’s 2009  operating income of approximately $1.1 million.  This disputed amount could change in future periods due to potential changes in the mix of cities in which Pinnacle operates.  In August 2009, Delta began to apply its interpretation of ground handling to the monthly wires that Pinnacle received, resulting in a net reduction of payments to Pinnacle of approximately $0.3 million for August and September.  In addition, Delta asserted that Pinnacle owes Delta a retroactive payment of approximately $4 million related to this ground handling issue.  We believe Delta’s assertions are invalid, and we continue to discuss this dispute with Delta.  If we are unable to resolve this dispute through discussions, we may jointly seek arbitration with Delta or pursue other legal options.

Finally, Delta has disputed its obligation to fully reimburse Pinnacle for its aviation insurance premiums.  During the second quarter of 2009, Delta requested that Pinnacle exit the Delta aviation insurance program and independently source its own aviation insurance.  Effective July 1, 2009, Pinnacle obtained its own independent insurance program at a cost significantly higher than what it was allocated by Delta under the Delta insurance program.  Delta has asserted that it is not obligated to reimburse the full costs of Pinnacle’s independent insurance program, despite the fact that both Pinnacle’s CRJ-200 ASA and CRJ-900 DCA require full reimbursement.  Delta has not reimbursed Pinnacle for approximately $1.5 million related to the third quarter of 2009.  We expect insurance premiums in future quarters to be approximately the same amount.  We believe Delta’s assertion is without merit, and we are reviewing our legal options to enforce our rights under our operating contracts with Delta.
 
 
23

 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 
       Our pro-rate operations, which account for approximately 20% of our consolidated revenue, are susceptible to changes in passenger demand and fuel price volatility.  We took a number of steps during 2008 to eliminate unprofitable markets, reduce costs, and increase revenue in our remaining pro-rate markets.  These steps and lower fuel prices have significantly reduced the operating losses of our pro-rate operations, and in fact, our pro-rate operations were profitable during the second and third quarters of 2009.  However, the airline industry is experiencing the effects of the current recessionary environment in the United States.  Industry passenger revenue has declined dramatically during 2009, and our pro-rate operations were negatively affected by this drop.  We cannot predict how severely the recessionary environment will affect us in the fourth quarter of 2009 and in 2010.  Further, our pro-rate operations are still susceptible to seasonal demand fluctuations, with passenger demand materially weaker during the fourth and first quarter of each year as compared to the seasonally high demand we typically experience in the second and third quarters of each year.  Similar to prior years, we do not expect to earn a significant amount of operating income from our pro-rate operations during the fourth quarter of 2009 or the first quarter of 2010.  Accordingly, similar to prior years, we expect a decline in our consolidated operating and net income as compared to our recent results in the second and third quarters of 2009.

We are in the process of relocating Colgan’s headquarters from Manassas, Virginia to Memphis, Tennessee.  We believe that relocating Colgan’s leadership team and system operations control center to our headquarters will enhance the financial and operational performance of Colgan long-term due to a lower cost of living and the sharing of operational and safety “best practices” between Pinnacle and Colgan.  In addition, we are negotiating with state and local authorities to obtain certain long-term incentives that will help offset the cost of relocating Colgan’s headquarters.  We expect the cost of relocation, training and infrastructure associated with this move to be as much as $3 million, and we incurred approximately $0.4 million of this cost during the third quarter of 2009.  We expect Colgan’s headquarters relocation to be completed early in the first quarter of 2010.

Pinnacle has been involved in negotiations with the Air Line Pilots Association (“ALPA”) since April 2005, when the collective bargaining agreement between the two parties became amendable.  On August 4, 2009, Pinnacle and ALPA reached a tentative agreement to amend the collective bargaining agreement.  However, Pinnacle’s pilots did not ratify the tentative agreement.  The National Mediation Board now controls the timing of further negotiations with ALPA, and we do not yet have information as to when further negotiations will take place.  The failed tentative agreement provided for an increase in compensation for Pinnacle’s pilots to the industry average, which is consistent with our company-wide philosophy of industry-average pay and benefits.  In addition, the failed tentative agreement called for a one-time signing bonus of approximately $10.2 million.  While we cannot predict what the terms of a new tentative agreement will contain, we do expect any new tentative agreement to substantially increase Pinnacle’s salaries, wages and benefits costs.

Colgan’s pilots also elected representation by ALPA in late 2008, and we recently began negotiations with ALPA.  It is too early in the negotiation process for us to predict the timing or impact of a new collective bargaining agreement with ALPA covering Colgan’s pilots.

Throughout 2009 we have been positioning ourselves for additional profitable growth opportunities in 2010 and beyond.  We recently agreed with Continental to expand our Continental CPA by acquiring 15 Q400 aircraft from August 2010 through April 2011.  We also acquired an additional 15 Q400 options from the aircraft manufacturer, thereby increasing the total remaining number of our Q400 options to 30.  These options, if exercised, provide for the delivery of 15 Q400s in 2011 and the remaining 15 in 2013.  The Q400 aircraft has become a very competitive product within the regional airline industry.  The purchase price of the Q400 is significantly less than that of comparably sized regional jets, and the Q400 uses up to 30% less fuel.  As a result, we can offer our airline partners a large, passenger-friendly regional aircraft with a lower operating cost than that of similar regional jets.

In addition to growing Colgan with the Q400 aircraft, we are positioning ourselves to capitalize on long-term opportunities to increase the number of regional jets that we operate at Pinnacle.  Capacity purchase agreements for over 400 50-seat regional jet aircraft at our competitors are set to expire between 2009 and 2015.  While many of these regional jets will likely no longer operate within the networks of the major U.S. airlines, we believe some of these contracts will be renewed or offered to other regional airlines and some will be replaced with larger regional jets.  We intend to actively compete to obtain profitable regional jet flying during this period of transition within the industry, and we believe our history of strong operating performance with a competitive cost structure will position us to succeed.  Our capacity purchase contracts do not begin to expire until December 2017.

 
24

 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations


Results of Operations

The following represents our results of operations, by segment and consolidated, for the three months ended September 30, 2009.  A discussion of our results of operations as compared to the same period in 2008 follows.

   
Three Months Ended September 30, 2009
 
   
Pinnacle
   
Colgan
   
Consolidated
 
   
(in thousands)
 
Operating revenues
                 
Regional airline services
  $ 152,704     $ 61,774     $ 214,478  
Other
    2,549       181       2,730  
Total operating revenues
    155,253       61,955       217,208  
                         
Operating expenses
                       
Salaries, wages and benefits
    40,651       14,751       55,402  
Aircraft rentals
    29,204       889       30,093  
Ground handling services
    19,007       2,957       21,964  
Aircraft maintenance, materials and repairs
    16,318       8,993       25,311  
Other rentals and landing fees
    12,301       5,358       17,659  
Aircraft fuel
    -       6,197       6,197  
Commissions and passenger related expense
    817       4,843       5,660  
Depreciation and amortization
    5,129       4,248       9,377  
Other
    16,140       5,609       21,749  
Total operating expenses
    139,567       53,845       193,412  
                         
Operating income
    15,686       8,110       23,796  
                         
Operating margin
    10.1 %     13.1 %     11.0 %
                         
Nonoperating income (expense)
                       
Interest income
                    277  
Interest expense
                    (11,989 )
Investment gain
                    4,233  
Miscellaneous income, net
                    101  
Total nonoperating expense
                    (7,378 )
Income before income taxes
                    16,418  
Income tax expense
                    (5,041 )
Net income
                  $ 11,377  


 
25

 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations



   
Nine Months Ended September 30, 2009
 
   
Pinnacle
   
Colgan
   
Consolidated
 
   
(in thousands)
 
Operating revenues
                 
Regional airline services
  $ 458,784     $ 170,830     $ 629,614  
Other
    6,393       286       6,679  
Total operating revenues
    465,177       171,116       636,293  
                         
Operating expenses
                       
Salaries, wages and benefits
    125,673       42,326       167,999  
Aircraft rentals
    87,564       3,115       90,679  
Ground handling services
    61,568       9,054