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EX-32 - SECTION 1350 CERTIFICATIONS - PINNACLE AIRLINES CORPexhibit32.htm
EX-23.1 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - PINNACLE AIRLINES CORPexhibit23-1.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER - PINNACLE AIRLINES CORPexhibit31-1.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER - PINNACLE AIRLINES CORPexhibit31-2.htm


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

Form 10-K

[X]
 
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the fiscal year ended December 31, 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)

Securities registered pursuant to Section 12(b) of the Act:
Title of each class:
Name of each exchange on which registered:
Common Stock, $.01 par value
Nasdaq Global Select Market
Securities registered pursuant to section 12 (g) of the Act: None

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes   [   ]
      
No   [ X ]
 
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes   [   ]
      
No   [ X ]
 
Indicate by check mark whether 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ]

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 (232.405 of this chapter) during the preceding twelve 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 large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
 
Large accelerated filer [   ]
 
Accelerated filer [   ]
     
Non-accelerated filer [ X ]
 
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 ]

The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the registrant was $48 million as of June 30, 2009.
 
As of February 22, 2010, 18,556,328 shares of common stock were outstanding.
 
Documents Incorporated by Reference
 
Certain information called for by Part III of Form 10-K is incorporated by reference to the Proxy Statement for our 2010 Annual Meeting of Stockholders to be filed with the Commission within 120 days after December 31, 2009.
 

 

TABLE OF CONTENTS

Part I
 
   Forward-Looking Statements  4
     
  4
    4
    5
    5
    6
    7
    9
    11
    13
    14
    14
    15
    15
    15
    16
    16
     
  17
     
  21
     
  22
    22
    22
     
  23
    23
    23
     
  23
     
 
Part II
 
     
  24
    25
     
  26
     
 
 
 
2

 

TABLE OF CONTENTS
(Continued)
 
 
 
 
 
Part IV
 
     
  99
     
  100

Certain statements in this Annual Report on Form 10-K (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, Section 21E of the Securities 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 solely on information available to us on the date of this Report.  We assume no obligation to update any forward-looking statement.

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 Item 1A Risk Factors and in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations under “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.

Part I

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,” “we,” and “us” except as otherwise noted.  Our subsidiaries will be referred to as “Pinnacle” for Pinnacle Airlines, Inc. and “Colgan” for Colgan Air, Inc., and collectively as “our subsidiaries.”

In October 2008, two of our major customers, Northwest Airlines Corporation and Delta Air Lines, Inc., merged to form the world’s largest passenger airline. Delta Air Lines, Inc. and its newly merged operating subsidiary, Northwest Airlines, Inc., are referred to herein as “Delta.”  Northwest Airlines Corporation and its subsidiaries as they existed prior to the merger are referred to herein as “Northwest.”

  US Airways Group, Inc. and its subsidiaries are collectively referred to as “US Airways.”  Continental Airlines, Inc. and its subsidiaries are collectively referred to as “Continental.”  United Air Lines, Inc. and its subsidiaries are collectively referred to as “United.”


Pinnacle Airlines Corp. was incorporated in 2003 as a Delaware corporation. As of December 31, 2009, we had two reportable segments consisting of Pinnacle and Colgan.  Information on our segments’ operating revenues, operating income, total assets, and other financial measures can be found in Note 4, Segment Reporting, in Item 8 of this Form 10-K.

Pinnacle operates an all-regional jet fleet, and provides regional airline capacity to Delta at its hub airports in Atlanta, Detroit, Memphis, and Minneapolis/St. Paul.  At December 31, 2009, Pinnacle operated 126 Canadair Regional Jet (“CRJ”)-200 aircraft under Delta brands with approximately 663 daily departures to 114 cities in 37 states and three Canadian provinces.  Pinnacle also operated a fleet of 16 CRJ-900 aircraft as a Delta Connection carrier with approximately 72 daily departures to 27 cities in 14 states, Belize, Mexico, Canada and the U.S. Virgin Islands.

 
4

 

Item 1.  Business

Our Company (Continued)

Colgan operates an all-turboprop fleet under a regional airline capacity purchase agreement (“CPA”) with Continental, and under revenue pro-rate agreements with Continental, United and US Airways.  Colgan’s operations are focused primarily in the northeastern United States and in Texas.  As of December 31, 2009, Colgan offered within its pro-rate operations 239 daily departures to 40 cities in ten states and the District of Columbia.  Colgan operated 12 Saab 340 aircraft as Continental Connection from Continental’s hub airport in Houston, 12 Saab 340 aircraft as United Express at Washington/Dulles, and ten Saab 340 aircraft as US Airways Express, at New York/LaGuardia and Boston, under revenue pro-rate agreements.  Colgan operated 14 Bombardier Q400 aircraft providing 90 daily departures to 17 cities in 11 states, the District of Columbia and two Canadian provinces as Continental Connection at Continental’s global hub at Newark/Liberty International Airport.


Regional Jet Operation

Pinnacle serves as our platform for regional jet operations.  Pinnacle operates regional jets under two CPAs  with Delta.  Our jet fleet consists of 50-seat CRJ-200 aircraft and 76-seat CRJ-900 aircraft operating in the Delta network. Our business strategy is to provide our major airline partners with safe, highly reliable and cost-efficient operations that distinguish us from our competitors. We are focused on providing excellent customer service and providing a safe and high quality travel experience.  Pinnacle’s unit cost continues to be competitive in the regional airline industry.

Turboprop Operation

Colgan serves as our platform for turboprop operations, providing a similar level of safe, reliable, and cost-efficient operations for our partners.  Colgan operates the 74-seat Q400 turboprop aircraft under a CPA with Continental.  The Q400 regional aircraft offers superior operating performance at a lower cost than similarly sized regional jets.  Colgan also operates under revenue pro-rate agreements with Continental, United, and US Airways, utilizing the Saab 340 aircraft, a 34-seat turboprop aircraft.


The airline industry is highly competitive. Pinnacle and Colgan compete principally with other code-sharing regional airlines.  In addition, through its revenue pro-rate agreements, Colgan competes in certain markets with regional airlines operating without code-share agreements, as well as low-cost carriers and major airlines.  Our primary competitors among regional airlines with capacity purchase arrangements include Comair, Inc. ("Comair"); Compass Airlines, Inc. (“Compass”); and Mesaba Aviation, Inc. (“Mesaba”) (all of which are wholly owned subsidiaries of Delta); Air Wisconsin Airlines Corporation; American Eagle Holding Corporation (“AMR Eagle”) (a wholly owned subsidiary of AMR Corporation); ExpressJet Holdings, Inc. ("ExpressJet"); Horizon Air Industries, Inc.  (“Horizon”) (a wholly owned subsidiary of Alaska Air Group Inc.); Mesa Air Group, Inc. ("Mesa"); Republic Airways Holdings Inc. ("Republic"); Skywest, Inc. (“Skywest”); and Trans States Airlines, Inc.

The principal competitive factors for regional airlines with capacity purchase agreements include the overall cost of the agreement, customer service, aircraft types, and operating performance. Many of the regional airlines competing for capacity purchase arrangements are larger, and may have greater financial and other resources than Pinnacle and Colgan. Additionally, regional carriers owned by major airlines, such as AMR Eagle, Comair, Horizon, and Mesaba, may have access to greater resources at the parent level than Pinnacle and Colgan, and may have enhanced competitive advantages because they are subsidiaries of major airlines.

 
5

 

Item 1.  Business

Competition and Economic Conditions (Continued)

Our competition within our pro-rate operations includes other domestic regional airlines and, to a certain extent, major and low-cost domestic carriers that maintain operations in the markets that we serve.  The principal competitive factors we experience with respect to our pro-rate flying include fare pricing, customer service, routes served, flight schedules, aircraft types and relationships with major partners. Moreover, competitors may easily shift capacity to enter our pro-rate markets and to offer discounted fares. The airline industry is particularly susceptible to price discounting because airlines incur only nominal incremental costs to provide service to passengers occupying otherwise unsold seats.

The airline industry is highly sensitive to general economic conditions, in large part due to the discretionary nature of a substantial percentage of both business and leisure travel. Many airlines have historically reported lower earnings or substantial losses during periods of economic recession, heavy fare discounting, high fuel costs and other disadvantageous environments. In the past, economic downturns combined with competitive pressures have contributed to a number of reorganizations, bankruptcies, liquidations and business combinations among major and regional carriers. We are somewhat insulated from the effect of economic downturns by the fact that most of our operations are conducted under capacity purchase agreements. Nonetheless, to the extent that our partners experience financial difficulties, they may seek ways to amend the terms of our capacity purchase agreements in a way that negatively affects our financial results.  Additionally, Colgan’s pro-rate operations, which operate similarly to an independent airline, are more directly affected by changes in the economy.


The airline industry in the United States has traditionally been dominated by several major airlines, including American Airlines, Inc., Continental, Delta, US Airways and United.  Low cost carriers, such as Southwest Airlines Co. ("Southwest"), JetBlue Airways Corporation ("JetBlue"), Frontier Airlines, Inc. ("Frontier") and AirTran Airways, Inc. ("AirTran"), generally offer fewer premium services to travelers and have lower cost structures than major airlines, which permits them to offer flights to and from many of the same markets as the major airlines, but at lower prices. Low cost carriers typically fly direct flights with limited service to smaller cities, concentrating on higher demand routes to and from major population bases.

Regional airlines, such as ExpressJet, Mesa and SkyWest, typically operate smaller aircraft on lower-volume routes than major and low cost carriers. Several regional airlines, including AMR Eagle, Comair, Compass, Horizon, and Mesaba, are wholly-owned subsidiaries of major airlines.

In contrast to low cost carriers, regional airlines generally do not seek to establish an independent route system to compete with the major airlines. Rather, regional airlines typically enter into relationships with one or more major airlines, pursuant to which the regional airline agrees to use its smaller, lower-cost aircraft to carry passengers ticketed by the major airline between a hub of the major airline and a smaller outlying city. In exchange for such services, the major airline pays the regional airline either a fixed flight fee, termed "capacity purchase" or "fixed-fee" flights, or the regional airline receives a percentage of applicable ticket revenues, termed "pro-rate" or "revenue-sharing" flights.

The growth in the number of passengers using regional airlines and the revenues of regional airlines during the last decade is attributable primarily to the introduction of regional jets and their popularity with major airlines.  Major airlines sought to add regional jets in many markets to replace smaller turboprop aircraft and slightly larger narrowbody jets.  By adding regional jets, hub and spoke carriers were able to increase the scope of their network by serving markets that could not be supported by a narrowbody aircraft, reduce the operating cost in markets previously supported by narrowbody jets, and increase the level of passenger service in smaller markets previously serviced with turboprop aircraft.

 
6

 

Item 1.  Business

Industry Overview (Continued)

Key to this strategy was the ability to outsource regional jet operations to regional airlines through the use of capacity purchase arrangements.  Regional airlines tend to have a more favorable cost structure and leaner corporate structure than many major airlines.  In addition, the complexities of multiple fleet types at an airline can increase costs because of the need to maintain multiple aircraft maintenance functions and multiple flight crew training functions.  By outsourcing regional jet operations to regional airlines, major airlines can reduce the number of aircraft types in their operating fleet while still enjoying the flexibility and revenue production that regional jets provide to their passenger network.  However, several major airlines have publicly indicated that their committed supply of regional airline capacity is larger than they desire given current market conditions.

Regional airlines generally enter into code-share agreements with major airlines, pursuant to which the regional airline is authorized to use the major airline's two-letter flight designator codes to identify the regional airline's flights and fares in the central reservation systems, to paint its aircraft with the colors and/or logos of its code-share partner and to market and advertise its status as a carrier for the code-share partner. For example, Pinnacle flies out of Detroit, Minneapolis/St. Paul, Memphis, and Atlanta under Delta brands. Colgan operates as Continental Connection out of Newark and Houston, United Express out of Washington/Dulles, and US Airways Express with significant operations at Boston and New York/LaGuardia.  In addition, the major airline generally provides services such as reservations, ticketing, ground support and gate access to the regional airline, and both partners often coordinate marketing, advertising and other promotional efforts. In exchange, the regional airline provides a designated number of low-capacity (usually between 30 and 76 seats) flights between larger airports served by the major airline and surrounding cities, usually in lower-volume markets.


Our operating contracts fall primarily into two categories: CPAs and revenue pro-rate agreements.  The following table presents for the year ended December 31, 2009 the percentage of our regional airline services revenue derived under each contract type and by code-share partner:

   
Percentage of Regional Airline Service Revenue
       
Pro-Rate Agreements
   
Source of Revenue
 
Capacity Purchase Agreements
 
Standard
 
Modified
 
Total
Delta
 
73%
 
-
 
-
 
73%
Continental
 
9%
 
-
 
7%
 
16%
United
 
-
 
-
 
5%
 
5%
US Airways
 
-
 
4%
 
-
 
4%
Essential Air Service
 
-
 
-
 
2%
 
2%
     Total
 
82%
 
4%
 
14%
 
100%

Capacity Purchase Agreements.  Our preferred contractual relationships with major airlines are structured as capacity purchase arrangements.  Under CPAs, our major airline partners purchase our flying capacity by paying pre-determined rates for specified flying, regardless of the number of passengers on board or the amount of revenue collected from passengers.  These arrangements typically include incentive payments that are paid if we meet certain operational performance measures.  Additionally, certain operating costs such as fuel, aviation insurance premiums, and ground handling are reimbursed or provided directly by the partner, which eliminates our risk associated with a change in the price of these goods or services.  We believe the capacity purchase model reduces our financial risk and enables us to focus on operating our business with the highest standards, while maximizing the efficiencies of the business that we provide to our partners.  Therefore, we are focused on growing the percentage of our revenue derived from these types of agreements by working to structure new business with capacity purchase terms.

 
7

 

Item 1.  Business

Our Operating Contracts (Continued)

Pinnacle’s Amended and Restated Airline Services Agreement (the “CRJ-200 ASA”) pertaining to its CRJ-200 operations and its Delta Connection Agreement pertaining to its CRJ-900 operations (“CRJ-900 DCA”) are both structured as CPAs.  In addition, Colgan’s Q400 operations for Continental are under a CPA (the “Continental CPA”).

Under our CPAs, most costs we incur are classified as one of the following:

·  
Reimbursed – Those costs that are reimbursed to the full extent of the actual cost, plus any applicable margin.
·  
Rate-based – We receive payments for each block hour and departure we provide and based upon the number of aircraft in our fleet.  These payments are designed to cover all of our expenses incurred with respect to the CPA that are not covered by the reimbursement payments, including overhead costs, but we assume the risk that our underlying costs for these activities differ from the assumptions used to negotiate the rates.
·  
Excluded – Services that are provided by or paid for directly by the code-share partner.  These costs do not appear on our financial statements.

The following is a summary of the treatment of certain costs under our three CPAs.

 
Continental CPA
CRJ-900 DCA
CRJ-200 ASA
Aircraft ownership
Rate-Based
Reimbursed(1)
Reimbursed
Aviation insurance
Reimbursed
Reimbursed
Reimbursed
Commissions and passenger distribution costs
Excluded
Excluded
Excluded
Facility rentals
Excluded(2)
Excluded(2)
Rate-Based(3)
Fuel
Excluded
Excluded
Excluded
Ground handling
Excluded(2)
Excluded(2)
Rate-Based(3)
Heavy maintenance
Rate-Based
Reimbursed(1)
Reimbursed
Labor costs
Rate-Based
Rate-Based
Rate-Based
Landing fees / station costs
Reimbursed
Reimbursed
Rate-Based(3)
Line maintenance
Rate-Based
Rate-Based
Rate-Based
Non-aircraft depreciation
Rate-Based
Rate-Based
Rate-Based
Other (G&A and training)
Rate-Based
Rate-Based
Rate-Based
Property taxes
Rate-Based
Reimbursed
Reimbursed

(1)
Reimbursement of these costs are both subject to a cap and adjusted downward should actual expenses incurred be less than the payments received.  Aircraft ownership reimbursements under the CRJ-900 DCA are based on principal and interest payments on debt associated with each aircraft.
 (2)
Ground handling and airport facilities are provided free of charge unless our partner asks us to perform ground handling in a station.  In these instances, we are compensated based upon negotiated ground handling rates.
 (3)
Landing fees that we incur in Detroit are reimbursed directly.  All other landing fees in our CRJ-200 operation are rate- based.  In addition, in certain cities under our CRJ-200 ASA, Delta provides or arranges for ground handling services on our behalf.  Our costs for these ground handling services, which include most other facility costs, are capped under the CRJ-200 ASA.

 
8

 

Item 1.  Business

Our Operating Contracts (Continued)

Revenue Pro-rate Agreements.  In addition to the Continental CPA, Colgan operates under contracts structured as revenue pro-rate code-share agreements, which allow for Colgan to market its operations under its partners’ brands.  Under these agreements, Colgan generally manages its own inventory of unsold capacity and sets fare levels in the local markets that it serves.  Colgan retains all of the revenue for passenger flying within Colgan’s local markets and not connecting to its partners’ flights.  For connecting passengers, the passenger fare is pro-rated between Colgan and its major airline partner, generally based on the distance traveled by the passenger on each segment of the passenger’s trip or on a comparison of unrestricted local fares within each segment.  Under these agreements, Colgan bears the risk associated with fares, passenger demand, and competition within its markets.  Colgan incurs all of the costs associated with operating these flights, including those costs typically reimbursed or paid directly by the major airline under a capacity purchase agreement. In some instances, Colgan has the ability to earn incentive-based revenue should it achieve specified performance metrics.

Colgan’s revenue pro-rate agreement with Continental is a modified pro-rate agreement in that it also contains a connecting passenger incentive designed to maintain a base level of revenue in the Houston markets that Colgan serves.  The connect incentive can be a payment from or a payment to Continental, depending on certain variables such as load factors, and is designed to create a more stable revenue level in these markets than could otherwise be supported under a traditional revenue pro-rate agreement.  The connect incentives rates are adjusted twice a year for changes in fuel prices and certain station/passenger related costs.

Colgan’s revenue pro-rate agreement with United is also a modified pro-rate agreement in that it includes a fixed connecting passenger incentive payment designed to subsidize some of the markets that Colgan operates in as United Express.  These markets would not be profitable on a stand-alone basis without the connecting passenger incentive.  The incentive amount is fixed for the three-year term of the agreement and may only be adjusted upon the concurrence of both Colgan and United.  Colgan has the ability to exit these markets to the extent that the markets can no longer be operated profitably with the fixed connecting passenger incentive payment.

In addition to operating its flights under revenue pro-rate code-share agreements, Colgan also operates some flights within its revenue pro-rate networks under Essential Air Service (“EAS”) contracts with the Department of Transportation (“DOT”).  The EAS program provides a federal government subsidy within certain small markets that could not otherwise sustain commercial air service because of limited passenger demand.


CRJ-200 Airline Services Agreement

Pinnacle provides regional jet service to Delta operating 126 50-seat CRJ-200 aircraft under the CRJ-200 ASA.  At the end of its term in 2017, the CRJ-200 ASA automatically extends for additional five-year periods unless Delta provides notice to us two years prior to the termination date that it does not plan to extend the term.

In addition to the rate-based and reimbursed payments previously detailed, our CRJ-200 ASA with Delta provides for margin payments.  The current rate-based payments will be in effect (subject to indexed annual inflation adjustments) through the end of 2012, when a negotiated rate reset will occur, which is designed to adjust our rate based compensation to cover our actual costs at that time. We receive a monthly margin payment based on the payments described above calculated to achieve a target operating margin of 8%. Delta does not guarantee Pinnacle’s minimum operating margin, although we are subject to a margin ceiling above the target operating margin.  If Pinnacle’s actual operating margin related to its operations under the CRJ-200 ASA for any year exceeds the 8% target operating margin but is less than 13%, Pinnacle will make a year-end adjustment payment to Delta in an amount equal to half of the excess above 8%.  If Pinnacle’s actual operating margin for any year exceeds 13%, Pinnacle will pay Delta all of the excess above 13%.   Margin calculations under the CRJ-200 ASA exclude amounts recognized as deferred ASA revenue, which is discussed in detail in Note 3, Code-Share Agreements, in Item 8 of this Form 10-K.

 
9

 

Item 1.  Business

Pinnacle’s Agreements with Major Airlines (Continued)

The CRJ-200 ASA provides that we will be required to negotiate with Delta an adjustment to our rates to the extent that we establish operations with another major airline.  Under the CRJ-200 ASA, upon reaching a certain level of operations outside of our CRJ-200 ASA, and to the extent that we have realized operating cost efficiencies from combining overhead in such outside operations, we will negotiate a rate reduction to the fixed payment that we receive under our CRJ-200 ASA related to our overhead.  We have discussed our current level of operations outside the CRJ-200 ASA with Delta, and in early 2010, we reached a tentative agreement to provide for a prospective rate reduction of $2 million in 2010 and $2.5 million in 2011, and $2.5 million in 2012 under this provision of the CRJ-200 ASA.  We do not expect this provision to result in further adjustments to our contract billings prior to our rate reset effective at the end of 2012.

To the extent that Pinnacle operates regional jets on behalf of another major airline, Delta may remove one aircraft for every two aircraft that Pinnacle operates for another partner above an initial base of 20 regional jets.  Delta may remove no more than 20 aircraft subject to this option and no more than five aircraft in any 12-month period.  Delta may only exercise this option if the removed aircraft are not operated by or on behalf of Delta after their removal.

Delta may terminate the CRJ-200 ASA at any time for cause.  Delta may also terminate the agreement at any time upon our bankruptcy or for any breach of the agreement by us that continues uncured for more than 30 days after we receive notice of the breach.  However, in the case of a non-monetary default, Delta may not terminate the agreement if the default would take more than 30 days to cure and we are diligently attempting to cure the default.  In addition, both Delta and we are entitled to seek an injunction and specific performance for a breach of the agreement.

In general, we have agreed to indemnify Delta and Delta has agreed to indemnify us for any damages caused by any breaches of our respective obligations under the CRJ-200 ASA or caused by our respective actions or inaction under the CRJ-200 ASA.

We recently reached a tentative agreement with Delta entered to resolve various other issues related to the CRJ-200 ASA.  These issues and their resolution are discussed in greater detail in Note 3, Code-Share Agreements, in Item 8 of this Form 10-K.

CRJ-900 Delta Connection Agreement (“CRJ-900 DCA”)

Pinnacle provides regional jet service to Delta operating 76-seat CRJ-900 aircraft under the CRJ-900 DCA.  The CRJ-900 DCA provides that Pinnacle operate 16 CRJ-900 aircraft under a capacity purchase agreement.  The CRJ-900 DCA allows Delta the option to add an additional seven CRJ-900 aircraft to the fleet.

The CRJ-900 DCA provides for Delta to pay pre-set rates based on the capacity we provide to Delta.  We are responsible for the costs of flight crews, maintenance, dispatch, aircraft ownership and general and administrative costs.  In addition, Delta reimburses us for certain pass-through costs, including landing fees, most station-related costs (to the extent that we incur them) and aircraft hull and general liability insurance.  In most instances, Delta will provide fuel and ground handling services free of charge.  We earn incentive payments (calculated as a percentage of the payments received from Delta) if we meet certain performance targets.  The CRJ-900 DCA also provides for reimbursements to Delta annually to the extent that our actual pre-tax margin on our Delta Connection operations exceeds certain thresholds.

The CRJ-900 DCA terminates for each aircraft upon the tenth anniversary of the in-service date of such aircraft.  Upon the sixth anniversary of the agreement date, which is April 27, 2013, either party has the right under the CRJ-900 DCA to remove from the terms of the agreement up to 20% of the CRJ-900 aircraft each year thereafter.

 
10

 

Item 1.  Business

Pinnacle’s Agreements with Major Airlines (Continued)

To the extent that either party materially breaches the CRJ-900 DCA and such breach remains uncured for a period of 30 days, the non-breaching party may terminate the agreement.  In addition, Delta may temporarily suspend or terminate the CRJ-900 DCA in the event of certain force majeure events that prevent either party from performing its obligations under the CRJ-900 DCA.  Delta may also terminate the CRJ-900 DCA upon certain corporate transactions such as a merger or change of control involving the Company, our failure to maintain a certain level of safety, our failure to maintain certain specified operational performance standards, our failure to adhere to various governmental operating regulations, our failure to maintain certain certifications and authorities, a material breach by us of our purchase agreement for our CRJ-900 aircraft with the manufacturer, or our failure to maintain specified levels of insurance.  Delta may also terminate the CRJ-900 DCA if Pinnacle commences operating a fleet type that causes Delta to be in violation of the collective bargaining agreement with its pilots.


Continental Connection Capacity Purchase Agreement (“Continental CPA”)

Colgan operates 74-seat Q400 turboprop regional aircraft predominantly out of Continental’s hub at Newark Liberty International Airport.  Colgan entered into the ten-year Continental CPA on February 5, 2007, which terminates for each aircraft upon the tenth anniversary of the in-service date of such aircraft.  Operations began on February 4, 2008, and we currently operate 14 Q400 aircraft under the Continental CPA.  In early 2009, we amended the Continental CPA to add an additional 15 Q400 aircraft, which are expected to deliver between August 2010 and April 2011.

The Continental CPA provides that we are compensated at pre-set rates for the capacity that we provide to Continental.  We are responsible for our own expenses associated with flight crews, maintenance, dispatch, aircraft ownership and general and administrative costs.  In addition, Continental reimburses us without a markup for certain reconciled costs, such as landing fees, most station-related costs not otherwise provided by Continental or its designee; aircraft hull and passenger liability insurance (provided that our insurance rates do not exceed those typically found at other Continental regional airline partners) and passenger related costs.  Continental will also provide to Colgan at no charge fuel and ground handling services at its stations.  Continental may request that we provide ground handling for our flights at certain stations, in which case, we will be compensated at a predetermined rate for these ground handling services.  The Continental CPA also provides for the ability to earn additional incentive-based revenue based upon achieving operational and financial performance targets.

The Continental CPA provides for a rate reduction to Continental to the extent that we begin operating Q400 aircraft for another major airline.  The rate reduction is designed to share the overhead burden associated with the Q400 aircraft across all of our potential Q400 operations and is only applicable for the first 15 aircraft that we add with another airline.

Continental may immediately terminate the Continental CPA following the occurrence of any event that constitutes cause.  To the extent that either party materially breaches the Continental CPA and such breach remains uncured for a period of 60 days, the non-breaching party may terminate the agreement.  Continental may also terminate the CPA upon certain corporate transactions such as a merger or change of control involving the Company, our failure to maintain a certain level of safety, our failure to maintain certain specified operational performance standards, or our failure to maintain various governmental certifications and to comply with various governmental operating regulations and authorities.

 
11

 

Item 1.  Business

Colgan’s Agreements with Major Airlines (Continued)

Continental Connection Pro-Rate Agreement

We operate 12 Saab 340 aircraft based in Houston, Texas under a code-share agreement with Continental (the “Continental Agreement”).  Colgan entered into the Continental Agreement in January 2005 for a term of five years.  The Continental Agreement is structured as a modified pro-rate agreement for which we receive all of the fares associated with local passengers and an allocated portion of the connecting passengers’ fares.  We pay all of the costs of operating the flights, including sales and distribution costs.  However, we also receive connect incentive payments from Continental for passengers connecting from Colgan operated flights to any flights operated by Continental or its other code-share partners at Houston/George Bush Intercontinental Airport.  The connect incentive payments are designed to maintain a base level of profitability in the markets that we fly out of Houston, and can result in a payment to us or from us depending on our passenger load factor in these markets.  The connect incentives are modified every six months to adjust for prospective modifications in fuel prices and certain station expenses.  We are currently in discussions with Continental about extending and/or modifying this agreement beyond its initial five year term, which ends in the second quarter of 2010.

US Airways Express Agreement

We operate ten Saab 340 aircraft under a code-share agreement with US Airways (the “US Airways Agreement”).  Colgan entered into the US Airways Agreement in 1999 to provide passenger service and cargo service under the name “US Airways Express.”  The US Airways Agreement provides us use of the US Airways flight designator code to identify flights and fares in computer reservations systems, permits use of logos, service marks, aircraft paint schemes, and uniforms similar to those used by US Airways and coordinated scheduling and joint advertising.  The US Airways Agreement is structured as a revenue pro-rate agreement for which we receive all of the fares associated with our local passengers and an allocated portion of connecting passengers’ fares.  We pay all of the costs of operating the flights, including sales and distribution costs.  We control all scheduling, inventory and pricing for each local market we serve.  The current three-year US Airways Agreement became effective on October 1, 2005 under terms similar to the 1999 agreement.  Since the end of the three-year term in 2008, the US Airways Agreement continues to automatically extend for multiple six-month periods until either party provides notice to terminate.

United Express Agreement

In October 2005, Colgan entered into a code-share agreement with United to provide services as a United Express carrier (the “United Express Agreement”).  The United Express Agreement was amended and restated effective November 1, 2008 and expires on November 1, 2011.  Colgan currently operates 12 Saab 340 aircraft under the name “United Express.” The United Express Agreement is structured as a modified pro-rate agreement for which we receive all of the fares associated with local passengers and an allocated portion of the connecting passengers’ fares.  In addition, United pays us a set passenger connect incentive fee for certain of the markets that we operate under the United Express Agreement.  The passenger connect incentive may only be adjusted during the three-year term by mutual consent of the parties.  We have the right, however, to cease serving certain of these markets to the extent that our operations are not profitable.  We pay all of the costs of operating the flights, including sales and distribution costs.  We jointly coordinate with United all scheduling, inventory and pricing for each local market we serve.

 
12

 

Item 1.  Business


As of December 31, 2009, we had 5,106 employees.  Flight attendants and ground operations agents included 239 and 839 part-time employees, respectively. The part-time employees work varying amounts of time, but typically work half-time or less. The follow table details the number of employees by company and by group:

Employee Group
 
Pinnacle Airlines Corp.
 
Pinnacle Airlines, Inc.
 
Colgan Air, Inc.
 
Total
Pilots
  -   1,178   403   1,581
Flight attendants
  -   695   282   977
Ground operations personnel
  -   962   192   1,154
Mechanics and other maintenance personnel
  -   504   308   812
Dispatchers and crew resource personnel
  -   285   81   366
Management and support personnel
  124   51   41   216
Total
  124   3,675   1,307   5,106

Labor costs are a significant component of airline expenses and can substantially affect our results. Approximately 78% and 52% of Pinnacle Airlines, Inc. and Colgan Air, Inc. employees, respectively, are represented by unions.

The following table reflects our principal collective bargaining agreements and their respective amendable dates:

Employee Group
 
Employees Represented
 
Representing Union
 
Contract Amendable Date
Pinnacle’s pilots
  1,178  
Air Line Pilots Association
 
April 30, 2005
Colgan’s pilots
  403  
Air Line Pilots Association
 
Pending (1)
Pinnacle’s flight attendants
  695  
United Steel Workers of America
 
February 1, 2011
Colgan’s flight attendants
  282  
United Steel Workers of America
 
April 30, 2014 (2)
Pinnacle’s ground operations agents
  929  
United Steel Workers of America
 
March 19, 2010 (3)
Pinnacle’s flight dispatchers
  67  
Transport Workers Union of America
 
December 31, 2013

(1) Initial contract negotiations commenced in October 2009 and are ongoing.
(2) The Colgan flight attendant agreement with the United Steel Workers of America is amendable on April 30, 2014 with the exception of a
      wage only review, which could occur in April 2011.
(3) The Company is currently in negotiations with the United Steel Workers of America in advance of the amendable date

The Railway Labor Act, which governs labor relations for unions representing airline employees, contains detailed provisions that must be exhausted before work stoppage can occur once a collective bargaining agreement becomes amendable.

 
13

 

Item 1.  Business

Employees  (Continued)

The collective bargaining agreement between Pinnacle and the Air Line Pilots Association (“ALPA”) became amendable in April 2005.  Pinnacle has been actively negotiating with ALPA since that time.  In August 2006, Pinnacle filed for mediation with the National Mediation Board.  Since then, Pinnacle has met with the federal mediator assigned to its case and with ALPA. 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 $10.2 million 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.


Using a combination of FAA-certified maintenance vendors and our own personnel and facilities, we maintain our aircraft on a scheduled and as-needed basis.  We perform preventive maintenance and inspect our engines and airframes in accordance with our FAA-approved maintenance policies and procedures.

The maintenance performed on our aircraft can be divided into three general categories: line maintenance, heavy maintenance checks, and engine and component overhaul and repair. Line maintenance consists of routine daily and weekly scheduled maintenance inspections on our aircraft, including pre-flight, daily, weekly and overnight checks and any diagnostic and routine repairs.

Pinnacle contracts with an affiliate of the original equipment manufacturer of its CRJ-200s to perform certain routine heavy maintenance checks on its aircraft.  Pinnacle also contracts with a third party to perform engine overhauls on its CRJ-200 fleet.  These maintenance checks are regularly performed on a schedule approved by the manufacturer and the FAA.  In general, both the CRJ-200 and CRJ-900 aircraft do not require their first heavy maintenance checks until they have flown approximately 8,000 hours.  The average age of the CRJ-200 and CRJ-900 regional jets in our fleet as of December 31, 2009 was approximately 6.7 years and 1.5 years, respectively.

Colgan performs its own heavy maintenance airframe checks for its Saab fleet at its maintenance facility in Houston, Texas, and occasionally contracts with third-party vendors for heavy maintenance airframe checks on an as-needed basis.  Colgan contracts with third parties to perform engine overhauls and propeller maintenance on its Saab fleet.  Colgan plans to use a combination of internal and third-party resources to complete heavy maintenance requirements on its Q400 fleet.  In general, the Q400 aircraft do not require their first heavy maintenance checks until they have flown approximately 4,000 hours.  The average age of the Q400 aircraft in our fleet as of December 31, 2009 was approximately 1.8 years.

Component overhaul and repair involves sending parts, such as engines, landing gear and avionics to a third-party, FAA-approved maintenance facility.  We are party to maintenance agreements with various vendors covering our aircraft engines, avionics, auxiliary power units and brakes.


Pinnacle performs the majority of its flight personnel training in Memphis, Tennessee both at its Corporate Education Center and the simulator center operated by FlightSafety International. FlightSafety International, at Pinnacle’s request, provides some overflow training at various other simulator centers throughout the U.S. and Canada.  The Memphis simulator center currently includes three CRJ full-motion simulators. Under Pinnacle’s agreement with FlightSafety International, Pinnacle has first priority on all of the simulator time available in the Memphis center.  Instructors used in the Memphis center are typically Pinnacle employees who are either professional instructors or trained line pilot instructors.

Colgan’s flight personnel are trained at various simulator centers throughout the U.S. and Canada under a contract with FlightSafety International.  Instructors that conduct the training are typically professional instructors or trained line pilot instructors.  Recurrent ground training takes place near the Colgan hubs including Newark, New Jersey, Washington, D.C. and Houston, Texas.  Upgrade training of Colgan flight personnel is performed at its Corporate Education Center in Memphis, Tennessee.

 
14

 

Item 1.  Business

Training (Continued)

We provide both internal and outside training for our maintenance personnel.  To maximize value for the Company and to ensure our employees receive the highest quality training available, we take advantage of manufacturers’ training programs offered, particularly when acquiring new aircraft.  We employ professional instructors to conduct training of mechanics, flight attendants and ground operations personnel in Memphis and Manassas.


We are committed to the safety and security of our passengers and employees.  Our most important Guiding Principle is “Never Compromise Safety.”  For example, Pinnacle led the way in the regional airline industry by being one of the first regional airlines to implement the Flight Operational Quality Assurance (“FOQA”) program. We are currently in the processing of implementing FOQA at Colgan.  FOQA programs involve the collection and analysis of data recorded during flight to improve the safety of flight operations, air traffic control procedures, and airport and aircraft design and maintenance.  In addition, we have implemented the FAA’s Aviation Safety Action Program (“ASAP”).  ASAP’s focus is to encourage voluntary reporting of safety issues and events that come to the attention of employees of certain certificate holders.   We also maintain a Line Observation Safety Audit (“LOSA”) program to obtain a self-evaluation of safety procedures that are invaluable in assessing opportunities for enhancing safety in flight operations.


We currently maintain insurance policies with necessary coverage levels for: aviation liability, which covers public liability, passenger liability, hangar keepers’ liability, baggage and cargo liability and property damage liability; war risk, which covers losses arising from acts of war, terrorism or confiscation; hull insurance, which covers loss or damage to our flight equipment; directors’ and officers’ insurance; property and casualty insurance for our facilities and ground equipment; and workers’ compensation insurance.

We were given the option under the Air Transportation Safety and Stabilization Act, signed into law on September 22, 2001, to purchase certain third-party war risk liability insurance from the U.S. government on an interim basis at rates that are more favorable than those available from the private market. As provided under this Act, we have purchased from the FAA this war risk liability insurance, which is currently set to expire on August 31, 2010.  We expect to renew the policy upon its expiration.


Our subsidiaries operate under air carrier certificates issued by the FAA and certificates of convenience and necessity issued by the DOT.  The DOT may alter, amend, modify or suspend these authorizations if the DOT determines that we are no longer fit to continue operations.  The FAA may suspend or revoke the air carrier certificate of one of our subsidiaries if the subsidiary fails to comply with the terms and conditions of the certificates. The DOT has established regulations affecting the operations and service of the airlines in many areas, including consumer protection, non-discrimination against disabled passengers, minimum insurance levels and others. Failure to comply with FAA or DOT regulations can result in civil penalties, revocation of the right to operate or criminal sanctions. FAA regulations are primarily in the areas of flight operations, maintenance, ground facilities, transportation of hazardous materials and other technical matters. The FAA requires each airline to obtain approval to operate at specific airports using specified equipment.  Under FAA regulations and with FAA approval, our subsidiaries have established a maintenance program for each type of aircraft they operate that provides for the ongoing maintenance of these aircraft, ranging from frequent routine inspections to major overhauls.  As of December 31, 2009, we had no unresolved significant violations.

 
15

 

Item 1.  Business


As with most airlines, we are subject to seasonality, though seasonality has historically had a lesser effect on our capacity purchase operations than it has on our pro-rate operations.  Mainline carriers use capacity purchase agreements because these arrangements allow them to expand their operations at lower fixed costs by using a regional’s lower cost structure for operating aircraft.  Because regional aircraft have lower fixed and variable costs than larger aircraft, mainline carriers tend to maintain regional aircraft utilization during seasons of reduced demand. Conversely, our financial results can be materially affected by the level of passenger demand for our services operated under pro-rate agreements, under which we more directly bear the risk of decreased demand for our services.  Our results can materially vary due to seasonality and cyclicality.  For example, Colgan has historically reported significant losses or significantly lower income during the first and fourth quarters of each year when demand for air travel is generally lower, and higher income during the second and third quarters of each year when demand for air travel increases.



Our website address is www.pncl.com.  All of our filings with the U.S. Securities and Exchange Commission (“SEC”) are available free of charge through our website on the same day, or as soon as reasonably practicable after we file them with, or furnish them to, the SEC.  Printed copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K may be obtained by submitting a request at our website.  Our website also contains our Code of Business Conduct, which contains rules of business conduct and ethics applicable to all of our directors and employees.  Any amendments to or waivers from the Code of Business Conduct in the future will be promptly posted to our website.


 
16

 


Risks Related to our Financial Condition

A. The global financial crisis could affect our business and financial condition in ways that we currently cannot predict.

While over the past several months the financial and credit markets have begun to stabilize, certain components of the capital markets remain illiquid and the availability of credit constrained.  Our prospective access to the capital markets to raise capital may be restricted, which could affect our ability to meet our obligations, our ability to react to changing economic and business conditions and our ability to grow our operations either through expansions of our existing agreements or the addition of new agreements. Additionally, while we currently have no outstanding hedges, the credit crisis could affect future hedging contracts if counterparties are forced to file for bankruptcy or are otherwise unable to perform their obligations.

B. Our fleet expansion program will require a significant increase in our leverage and the related cash outflows.

Our recent growth strategy has required significant amounts of capital to acquire CRJ-900 and Q400 regional aircraft.  As a result, we have significantly increased our total debt obligations and our leverage over the past three years.  During the year ended December 31, 2009, our mandatory debt service payments totaled approximately $130 million, and we expect this amount to increase through April 2011 as we acquire and finance 15 additional Q400 aircraft.  See related risk factor A for additional information related to credit availability.

There can be no assurance that our operations will generate sufficient cash flow or liquidity to enable us to obtain the necessary aircraft acquisition financing for future growth, or to make required debt service payments related to our existing obligations.  If we default under our loan, lease or aircraft purchase agreements, the lender/lessor/manufacturer has available extensive remedies, including, without limitation, repossession of the respective aircraft and other assets. Even if we meet all required debt, lease, and purchase obligations, the size of these long-term obligations could negatively affect our financial condition, results of operations and the price of our common stock in many ways, including:

 
increasing the cost, or limiting the availability of, additional financing for working capital, acquisitions or other purposes;
 
limiting the ways in which we can use our cash flow, much of which may have to be used to satisfy debt and lease obligations; and
 
adversely affecting our ability to respond to changing business or economic conditions or continue our growth strategy.

If we need additional capital and cannot obtain such capital on acceptable terms, or at all, we may be unable to realize our current plans or take advantage of unanticipated opportunities and could be required to slow or stop our growth.

C. We are increasingly dependent on technology in our operations, and if our technology fails, our business may be adversely affected.

Our subsidiaries’ systems operations control centers, which oversee daily flight operations, are dependent on a number of technology systems to operate effectively.  Large scale interruption in technology infrastructure that we depend on, such as power, telecommunications or the internet, could cause a substantial disruption in our operations, which could lead to poor operating performance, loss of regional airline services revenue, and financial penalties under our operating contracts.   In some instances, if the disruption to our operations was severe, our major airline partners could have the right to terminate our operating contracts.

 
17

 

Item 1A. Risk Factors

Risks Related to our Code-Share Agreements

D. There are long-term risks related to supply and demand of regional aircraft associated with our regional airline services strategy.

Many of our major airline partners have publicly indicated that their committed supply of regional airline capacity is larger than they desire given current market conditions.  Specifically, they cite an oversupply of 50-seat regional jets under contractual commitments with regional airlines.  Delta in particular has indicated that it plans to reduce both the number of 50-seat regional jets within its network and the number of regional airlines with which it contracts.  There are currently more than 400 50-seat aircraft within the Delta Connection system, more than any other major carrier worldwide.  In addition to reducing the number of 50-seat jets under contract, major airlines have reduced the utilization of regional aircraft, thereby reducing the revenue paid to regional airlines under capacity purchase agreements.  The utilization by Delta of our 50-seat CRJ-200 aircraft decreased by 7% in 2009.  This decrease had a negative impact on our regional airline services revenue and profitability.

Mesa Airlines, one of our regional airline competitors, recently filed for Chapter 11 Bankruptcy reorganization.  This was caused in large part by a significant number of regional aircraft that it owns or leases but that are no longer committed to fly under an agreement with a major airline partner.  As major airlines seek to reduce the number of 50-seat aircraft within their networks, other regional airlines may also be forced to restructure their operations.  In an environment where the supply of regional aircraft exceeds the demand from our major airline partners, our competitors may price their regional airline products below cost or otherwise compete aggressively to retain business.   In addition, regional airlines with more financial resources may make loans or pay financial incentives to retain or increase business with major airlines.  For example, SkyWest Airlines recently extended loans of up to $129 million to United in exchange for an extension on the term of some of its regional airline services agreements with United.  Regional airlines with more financial resources may also acquire or merge with other regional airlines in an attempt to mitigate any reductions of regional airline services with their major airline partners.

We have fewer financial resources than many of our competitors, and therefore we may be at a competitive disadvantage as we compete for new business opportunities.  Additionally, while our CRJ-200 ASA with Delta contractually extends through December 31, 2017, Delta may still seek to reduce our level of operations, either through reduced utilization of our fleet or through attempted reductions in the number of aircraft that we operate.   Oversupply of regional aircraft may also lead to reductions of service under our operating agreements with our other partners.  These reductions in service may lead to reduced profitability and we may be forced to sell, sublease, or otherwise reduce the number of aircraft that we own or lease.

E. We are highly dependent upon our regional airline services agreements with Delta.

We are highly dependent on Delta, our largest customer.  Our code-share agreements with Delta generate approximately 73% of our consolidated regional airline service revenue, and nearly 75% of our operating fleet is utilized by Delta.  In addition, our entire fleet of 126 CRJ-200 aircraft is subleased from Delta under leases that terminate if our airline services agreement with Delta terminates.  We would be significantly negatively affected should one of our code-share agreements with Delta be terminated, and we likely would be unable to find an immediate source of revenue or earnings to offset such a loss.  We may be unable to enter into substitute code-share arrangements, and any such arrangements we might secure may not be as favorable to us as our current agreements.  Operating as an independent airline is a departure from our business strategy and would require considerable time and resources.

 
18

 

Item 1A. Risk Factors

Risks Related to our Code-Share Agreements (Continued)

            Our code-share agreements with Delta and our other partners include various minimum operating performance requirements, which if we fail to meet, provide the partner with the ability to terminate the agreement with little or no notice requirement.  Certain conditions that are beyond our control, such as weather, may negatively affect our performance such that we may fall below the minimum operating requirements.  For example, in June 2008, Delta gave notice to Pinnacle that it intended to terminate Pinnacle’s CRJ-900 DCA, citing failure to meet on-time performance requirements in the CRJ-900 DCA.  We disputed Delta’s right to terminate the CRJ-900 DCA, and we subsequently agreed with Delta to continue operating under the CRJ-900 DCA.  Although we were successful in this instance in keeping our CRJ-900 DCA intact with Delta, a future attempt by Delta or an attempt by another of our partners to terminate one of our code-share agreements resulting from our failure to meet our minimum operating performance requirements would, if successful, have a material negative impact on our financial performance and liquidity. 

We are also currently in discussion with Delta to resolve certain significant disputed contractual matters, as discussed in Note 3, Code-Share Agreements with Partners, in Item 8 of this Form 10-K.  These unresolved disputes, or future disagreements over interpretation of our code-share agreements, may result in materially unfavorable adjustments to our revenue and profitability related to our Delta code-share operations.

F. We are highly dependent upon the services provided by our major airline partners.

We are highly dependent upon Delta and Continental, our capacity purchase agreements partners, for the services they provide to support our current operations.  For example, we currently use or rely upon Delta's, Continental’s and to a lesser degree our pro-rate partners’ systems, facilities and services to support a significant portion of our operations, including airport and terminal facilities and operations, information technology support, ticketing and reservations, scheduling, dispatching, fuel purchasing and ground handling services.  Were we to lose any of our operations with these partners, particularly related to our CRJ-900 DCA and Continental CPA agreements with Delta and Continental, respectively, for which we bear the ownership risks associated with the aircraft, we would need to replace all of the services mentioned above and make the other arrangements necessary to fly as an independent airline or otherwise find a suitable use for the aircraft.

G. The rate-based revenues we receive under our capacity purchase code-share agreements may be less than the controllable costs we incur.

Under our capacity purchase code-share agreements with Delta and Continental, the major airline bears the risk related to the cost of certain reimbursable expenses that they are contractually required to repay in full to us.  With respect to other costs, often called “rate-based,” our code-share partner is obligated to pay to us amounts at predetermined rates based on the level of capacity that we generate for them.  If our controllable costs exceed our rate-based revenue, our financial results will be adversely affected.  For example, certain CRJ-200 maintenance expenses are intended to be covered by our rate-based revenue.  As our CRJ-200 fleet ages, the maintenance costs required to support the fleet are increasing, which places additional pressure on our profitability.  During the year ended December 31, 2009, approximately 33% of our total costs were pass-through costs and approximately 67% of our costs were controllable costs related to our rate-based revenue.
 
H. Our ability to operate profitably under Colgan’s pro-rate code-share agreements is heavily dependent on the price of aircraft fuel. Recent volatility in the price of fuel presents a market uncertainty and could have a significant negative impact on our operating results.
 
Under our pro-rate code-share agreements, we bear the risk associated with fares, passenger demand, and competition within each market.  Similarly, we also incur all of the costs associated with operating these flights, including those costs typically reimbursed or paid directly by the major airline under a capacity purchase agreement. For example, Colgan’s pro-rate agreements expose Colgan to fuel price volatility.  In recent times, fuel prices have been extremely volatile, increasing by over 100% or decreasing by over 50% over a period of just a few months.  Our ability to offset increases in the price of fuel by raising fares or surcharges may be limited, primarily because of reduced demand for air travel and competitiveness of the airline industry.  To the extent that we incur expenses that exceed the revenue we receive from passenger fares and incentive-based revenue, our financial results will be negatively affected.

 
19

 

Item 1A. Risk Factors

Risks Related to our Code-Share Agreements (Continued)

I. We are at risk of adverse publicity stemming from any accident involving our aircraft.
 
While we believe the insurance we carry to cover losses arising from an aircraft crash or other accident is adequate to cover such losses, any accident involving an aircraft that we operate for one of our code-share partners could create a public perception that our aircraft or operations are not safe or reliable.  Such a perception could harm our reputation, result in the loss of existing business with our code-share partners, result in an inability to win new business and harm our profitability. For a description of the Colgan Flight 3407 accident in which all 49 people aboard and an individual on the ground died, see Legal Proceedings in Item 3 of this Form 10-K.

J.  Changes in government regulations imposing additional requirements and restrictions on our operations could increase our operating costs and result in service delays and disruptions.

 
Airlines are subject to extensive regulatory and legal requirements that involve significant compliance costs.  In the last several years, Congress has passed laws, and the DOT, FAA and the TSA have issued regulations relating to the operation of airlines that have required significant expenditures.  We expect to continue to incur expenses in connection with complying with government regulations.  The FAA is currently drafting new requirements, and depending on whether the final rules incorporate significant changes to crew rest requirements, our cost structure could be adversely affected. We cannot predict the effect that these and other laws or regulations enacted in the future will have on our business.

Risks Related to our Labor Costs and Collective Bargaining Agreements

K. Increases in our labor costs, which constitute a substantial portion of our total operating costs, may directly affect our earnings.

Labor costs are not directly reimbursed by any of our code-share partners.  Rather, compensation for these costs is intended to be covered by the payments based on pre-set rates for block hours, departures and fixed costs.  Labor costs constitute a significant portion, ranging from 28% to 30%, of our total operating costs.  Pressure to increase these costs beyond standard industry wages, and therefore beyond the limits intended to be covered by the fixed payments we receive from our code-share partners, is increased by the high degree of unionization of our workforce.  As of December 31, 2009, 70% of our employees were unionized.  Additionally, the new terms of a revised collective bargaining agreement with our pilots at Pinnacle and a new collective bargaining agreement with our pilots at Colgan will materially increase our salaries, wages and benefits costs.  Pinnacle’s pilots are currently paid at rates less than the industry average for similarly sized aircraft, and an amended collective bargaining agreement with ALPA is expected to contain higher rates of pay for Pinnacle’s pilots.  In addition, while we have not offered retroactive compensation to Pinnacle’s pilots during the negotiation process, an amended collective bargaining agreement may contain a material signing bonus.  An increase in our labor costs over standard industry wages could result in a material reduction to our earnings, and could affect our future prospects for additional business opportunities.

L. Strikes or labor disputes with our employees may adversely affect our ability to conduct our business and could result in the termination, or a significant reduction of the benefit, of our code-share agreements.

If we are unable to reach collective bargaining agreements upon their initial or amendable dates with any of our unionized work groups in accordance with the Railway Labor Act, we may be subject to work interruptions, work stoppages, or a fleet size reduction.  Work stoppages may adversely affect our ability to conduct our operations and fulfill our obligations under our code-share agreements.   Several of our code-share agreements, including our Continental CPA, our CRJ-900 DCA, and our CRJ-200 ASA, contain provisions granting our partners the right to terminate our agreements in the event of a work stoppage or labor strike.  Additionally, our CRJ-200 ASA contains a provision allowing Delta to reduce the size of our CRJ-200 fleet in the event of a work stoppage or labor strike.

 
20

 

Item 1A. Risk Factors

Risks Related to our Labor Costs and Collective Bargaining Agreements (Continued)

Our collective bargaining agreement with the Air Line Pilots Association, the union representing Pinnacle’s pilots, became amendable on April 30, 2005. In September 2009, the pilots voted against the ratification of a tentative agreement to amend the collective bargaining agreement.  While our future negotiations with ALPA will be conducted under the oversight of the National Mediation Board, as a result of their vote against the tentative agreement, we are unable to predict when an agreement could be reached.  Consequently, we remain at risk of a strike by our pilots should the National Mediation Board release our pilots from the negotiations and should we fail to obtain an agreement with ALPA before the parties are legally entitled to self help under the Railway Labor Act.

M.  If we are unable to attract and retain key employees, our business could be harmed.

We compete against the other major and regional U.S. airlines for pilots, mechanics and other employee groups essential for providing airlines services.  Several of the other airlines offer wage and benefit packages that exceed ours.  We may be required to increase wages and/or benefits in order to attract and retain qualified employees or risk considerable turnover, which could negatively affect our ability to provide a quality product to our customers and therefore negatively affect our relationship with our customers.  Similarly, as we further expand our Q400 operations for Continental, our need for qualified pilots, mechanics and other airline-specific employees increases.  For example, Pinnacle’s ongoing negotiation with ALPA for an amended collective bargaining agreement may complicate our ability to both attract and retain pilots, one of our key employee groups.  If we are unable to hire, train and retain qualified pilots we would be unable to efficiently run our operations and our competitive ability would be impaired.  Our business could be harmed and revenue reduced if, due to a shortage of pilots, we are forced to cancel flights and forego earning incentive-based revenue under our code-share agreements.


All staff comments received from the Securities and Exchange Commission were resolved as of the date of this filing.

 
21

 



As shown in the following table, the Company’s aircraft fleet consisted of 142 regional jet aircraft and 48 turboprop aircraft at December 31, 2009.

Aircraft Type
 
Number of Aircraft
 Leased
 
Number of Aircraft
Owned
 
Total
Aircraft
 
Standard Seating Configuration
 
Average Age
(in years)
CRJ-200
 
126
 
-
 
126
 
50
 
6.7
CRJ-900
 
-
 
16
 
16
 
76
 
1.5
   Total regional jets
 
126
 
16
 
142
       
Saab 340
 
11(1)
 
23
 
34
 
34
 
18.4
Q400
 
-
 
14
 
14
 
74
 
1.8
   Total turboprops
 
11
 
37
 
48
       
   Total aircraft
 
137
 
53
 
190
       

(1)  
In addition, for purposes of classification, two of the 11 leased aircraft were operated under capital leases. For further discussion, refer to Note 9, Leases, in Item 8 of this Form 10-K.


The Company had the following significant dedicated facilities as of December 31, 2009:
Location
 
Description
 
Square Footage
 
Lease Expiration Date
Memphis, TN
 
Pinnacle Airlines, Inc. Headquarters and Corporate Education Center
 
59,100
 
August 2011
             
Memphis, TN
 
Pinnacle Airlines Corp. and Colgan Air, Inc. Headquarters
 
27,756
 
December 2010
             
Memphis, TN
 
Hangar and Maintenance Facility
 
51,250
 
December 2016
             
Knoxville, TN
 
Hangar and Maintenance Facility
 
55,000
 
Termination of the CRJ-200 ASA
             
Dulles, VA
 
Hangar and Maintenance Facility
 
44,029
 
April 2011
             
Albany, NY
 
Hangar and Maintenance Facility
 
24,325
 
December 2010
             
Houston, TX
 
Hangar and Maintenance Facility
 
24,325
 
March 2011

Our significant maintenance facilities are located in cities that we serve based on market size, frequency, and location.  These facilities are used for overnight maintenance; however, Memphis and Dulles are also used during the day.  We have additional smaller maintenance facilities in Atlanta, Georgia, Fort Wayne, Indiana and South Bend, Indiana.  While the facilities are highly utilized with an average turn around time of seven to ten hours, we believe that our existing facilities are adequate for the foreseeable needs of our current and growing business.  As our fleet grows, we may seek additional maintenance space in the future.

In connection with our code-share partners, we maintain contract service agreements with Delta, Continental, United and US Airways allowing for the use of terminal gates, parking positions and operations space at Atlanta, Boston Detroit, Houston, Memphis, Minneapolis/St. Paul, Newark, New York LaGuardia and Washington Dulles airports, as well as most of the stations we serve from these hub airports.  We believe the use of the terminal gates, parking positions, and operations space obtained from our code-share partners will be sufficient to meet the operational needs of our business.

 
22

 


Pinnacle and Colgan are subject to certain legal actions that occur in the ordinary course of our business. While the outcome of these actions cannot be predicted with certainty, it is the opinion of our management, based on current information and legal advice, that the ultimate disposition of these actions will not have a material adverse effect on our financial statements as a whole.  For further discussion, see Note 16, Commitments and Contingencies, in Item 8 of this Form 10-K.

September 11, 2001 Litigation.  Colgan is a defendant in litigation resulting from the September 11, 2001 terrorist attacks.  The Company believes it will prevail in this litigation; however, the Company believes that any adverse outcome from this litigation would be covered by insurance and would therefore have no material adverse effect on the Company’s financial position, results of operations and cash flows.

Colgan Flight 3407.  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, increasing the total fatality count to 50 individuals.  Several lawsuits related to this accident have been filed against the Company, and additional litigation is anticipated.  We carry aviation liability insurance and believe that this insurance is sufficient to cover any liability arising from this accident.


We are subject to regulation under various environmental laws and regulations, which are administered by numerous state and federal agencies. In addition, many state and local governments have adopted environmental laws and regulations to which our operations are subject. We are, and may from time to time become, involved in environmental matters, including the investigation and/or remediation of environmental conditions at properties used or previously used by us. We are not, however, currently subject to any environmental cleanup orders imposed by regulatory authorities, nor do we have any active investigations or remediations at this time.


We are subject to regulation under various laws and regulations which are administered by numerous state and federal agencies, including but not limited to the FAA, DOT and Transportation Security Administration (“TSA”).  We are involved in various matters with these agencies during the ordinary course of our business.  While the outcome of these matters cannot be predicted with certainty, it is the opinion of our management, based on current information and past experience, that the ultimate disposition of these matters will not have a material adverse effect on our financial condition as a whole.


None.

 
23

 

 
Part II
 

The shares of our common stock are quoted and traded on the Nasdaq Global Select Market under the symbol “PNCL.” Our common stock began trading on November 25, 2003, following our initial public offering. Set forth below, for the applicable periods indicated, are the high and low closing sale prices per share of our common stock as reported by the Nasdaq Global Select Market.

2009
 
High
   
Low
First quarter
  $ 2.67     $ 1.00
Second quarter
  $ 3.19     $ 1.39
Third quarter
  $ 7.66     $ 2.55
Fourth quarter
  $ 7.53     $ 5.75

2008
 
High
   
Low
First quarter
  $ 15.32     $ 8.73
Second quarter
  $ 9.31     $ 3.14
Third quarter
  $ 7.00     $ 3.05
Fourth quarter
  $ 4.13     $ 1.69

As of February 22, 2010, there were approximately 35 holders of record of our common stock.  We have paid no cash dividends on our common stock and have no current intention of doing so in the future.

The information under the caption “Securities Authorized for Issuance under Equity Compensation Plans,” appearing in the Proxy Statement for our 2010 Annual Meeting of Stockholders, to be filed with the Commission within the 120 days after December 31, 2009, is hereby incorporated by reference.

Our Certificate of Incorporation provides that no shares of capital stock may be voted by or at the direction of persons who are not United States citizens unless such shares are registered on a separate stock record. Our Bylaws further provide that no shares will be registered on such separate stock record if the amount so registered would exceed United States foreign ownership restrictions. United States law currently limits to 25% the voting power in our company (or any other U.S. airline) of persons who are not citizens of the United States.

 
24

 
 
Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities


The following graph compares total shareholder return on the Company’s common stock over the five-year period ending December 31, 2009, with the cumulative total returns (assuming reinvestment of dividends) on the American Stock Exchange Airline Industry Index and the NASDAQ Composite Index. The stock performance graph assumes that the value of the investment in our common stock and each index (including reinvestment of dividends) was $100 on December 31, 2004. The graph below represents historical stock performance and it not necessarily indicative of future stock price performance.

Performance Graph



This selected consolidated financial data should be read together with the audited consolidated financial statements and related notes contained in Item 8, Management’s Discussion and Analysis of Financial Condition and Results of Operation contained in Item 7, and Risk Factors in Item 1A of this Form 10-K.

 
Years Ended December 31,
 
 
2009
   
2008
(Restated)
   
2007
(Restated)
   
2006
(Restated)
   
2005
(Restated)
 
 
(in thousands, except per share data)
 
Statement of Operations Data:                            
Total operating revenues(1)(2)
$ 845,508     $ 864,785     $ 787,374     $ 824,623     $ 841,605  
Total operating expenses (3)
  764,799       819,178       734,963       697,075       814,676  
Operating income(1)(2)(3)
  80,709       45,607       52,411       127,548       26,929  
Operating income as a percentage of operating revenues(1)(2)(3)
  9.5 %     5.3 %     6.7 %     15.5 %     3.2 %
Nonoperating (expense) income(4)(5)
  (38,471 )     (54,196 )     (8,462 )     (10,706 )     8,498  
Income tax expense(4)(6)
  (382 )     (2,408 )     (13,526 )     (43,758 )     (13,364 )
Net income (loss) (4)
  41,856       (10,997 )     30,423       73,084       22,063  
Basic earnings (loss) per share (4)
$ 2.33     $ (0.62 )   $ 1.46     $ 3.33     $ 1.01  
Diluted earnings (loss) per share (4)
$ 2.31     $ (0.62 )   $ 1.32     $ 3.33     $ 1.01  
Shares used in computing basic earnings (loss) per share
  17,969       17,865       20,897       21,945       21,913  
Shares used in computing diluted earnings (loss) per share
  18,133       17,865       23,116       21,974       21,932  
 
1.
Our target operating margin under the CRJ-200 ASA was 10% from December 1, 2003 through December 31, 2006. Under the CRJ-200 ASA effective January 1, 2007, Pinnacle’s CRJ-200 ASA target operating margin was reduced to 8% and certain significant reimbursed expenses such as fuel and aircraft rentals were eliminated or reduced, resulting in lower revenue, expenses and income. In addition, operating revenues and operating income for the years ended December 31, 2009, 2008 and 2007 include $23.1 million, $24.0 million and $22.6 million, respectively, of deferred revenue recognized related to our Northwest bankruptcy claim.  For further discussion of the target operating margin and deferred revenue, refer to Note 3, Code-Share Agreements with Partners, in Item 8 of this Form 10-K.
2.
Operating revenues and operating income for the year ended December 31, 2007 were affected by the January 18, 2007 acquisition of Colgan, offset by changes in CRJ-200 ASA with Delta.  Operating revenues and operating income for the years ended December 31, 2009 and 2008 were affected by additional revenue earned under our CRJ-900 DCA and our Continental CPA.  We began operating under our DCA in December 2007, and we began operating under our Continental CPA in February 2008.  For more information, refer to Note 3, Code-Share Agreements with Partners, in Item 8 of this Form 10-K.
3.
Operating expenses for the years ended December 31, 2007, 2006 and 2005 were affected by (benefits)/charges of ($1.0 million), ($43.6 million), and $59.6 million, respectively, related to the bankruptcies of Northwest and Mesaba. For more information, refer to Note 3, Code-Share Agreements with Partners, in Item 8 of this Form 10-K.  In addition, operating expenses for the year ended December 31, 2007 were affected by the acquisition of Colgan.  As previously mentioned, Colgan was acquired on January 18, 2007.  Operating expenses for the year ended December 31, 2008 were affected by a $13.5 million impairment charge on Colgan’s goodwill and aircraft retirement costs. For more information, refer to Note 14, Impairment and Aircraft Retirement Costs, in Item 8 of this Form 10-K.
4.
A new accounting standard related to convertible debt became effective for and was adopted by the Company beginning January 1, 2009.  This standard required retrospective application to the terms of instruments as they existed for all periods presented. As such, results for the years ended December 31, 2008 through 2005 have been restated to reflect the revised accounting requirement.  For more information, see Note 7, Borrowings, in Item 8 of this Form 10-K.
5.
Nonoperating income for the year ended December 31, 2005 includes a gain of $18.0 million related to the repurchase of our note payable to Northwest.  Nonoperating income for the year ended December 31, 2008 includes a $16.8 million impairment charge on our ARS investments.  For more information on the impairment charge on our ARS investments, refer to Note 6, Investments and Fair Value Measurements, in Item 8 of this Form 10-K.  In addition, nonoperating expense for the years ended December 31, 2008 and 2009 includes interest expense on the financing for the CRJ-900 and Q400 aircraft.  For more information related to aircraft financing, refer to Note 7, Borrowings, in Item 8 of this Form 10-K.  Nonoperating expense for the year ended December 31, 2009 includes a net gain of $3.9 million, primarily related to the sale of our Auction Rate Securities (“ARS”) portfolio, and a reduction to interest expense of $2.9 million related to the reversal of accrued interest on tax reserves.  For more information, see Note 6, Investments and Fair Value Measurements, and Note 13, Income Taxes, in Item 8 of this Form 10-K.
6.
Income tax expense for the year ended December 31, 2009 includes a benefit of $13.6 million related to the settlement of the Internal Revenue Service’s examination of the Company’s federal income tax returns for calendar years 2003, 2004, and 2005.  For more information, refer to Note 13, Income Taxes, in item 8 of this Form 10-K.

 
 

 



 
26

 

Item 6.  Selected Financial Data

   
As of December 31,
 
 
 
2009
   
2008
(Restated)
   
2007
(Restated)
   
2006
(Restated)
   
2005
(Restated)
 
   
(in thousands)
 
 Balance Sheet Data:                              
Cash and cash equivalents (7)
  $ 91,574     $ 69,469     $ 26,785     $ 705     $ 31,567  
Investments
    2,723       116,900       186,850       72,700       44,160  
Property and equipment, net (8)(4)
    731,073       719,931       257,168       40,985       42,535  
Total assets (10)(4)
    1,289,420       1,127,702       699,548       299,185       226,994  
Long-term debt obligations, including capital leases (9)(4)
    521,961       603,026       174,208       90,208       82,730  
Stockholders' equity (deficiency) (4)
    102,237       55,734       71,054       114,468       40,779  
 
7.
For the year ended December 31, 2006, cash and cash equivalents did not include the normal CRJ-200 ASA end-of-month payment of $31.9 million, which was received on January 2, 2007 as December 31, 2006 fell on a non-business day.
8.
As of December 31, 2007, property and equipment included the addition of three CRJ-900 aircraft.  As of December 31, 2008, property and equipment include an additional 11 CRJ-900 aircraft and 15 Q400 aircraft that were received during 2008.
9.
Long-term debt obligations as of December 31, 2007 include financing for three CRJ-900 aircraft.  Long-term debt obligations as of December 31, 2008 include financing for 11 additional CRJ-900 aircraft and 15 Q400 aircraft that were entered into during 2008.
10.
For the year ended December 31, 2009, total assets include approximately $300 million on long-term receivables related to potential claims related to Colgan Flight 3407. This amount is offset in its entirety by a corresponding liability.  For more information, see Note 16, Commitments and Contingencies, in Item 8 of this Form 10-K.
 
 
27

 

Item 6.  Selected Financial Data

   
Years Ended December 31,
 
      2009(12)       2008(12)       2007(11)       2006       2005  
                                         
Other Data:
                                       
Revenue passengers (in thousands)
    13,473       12,926       11,494       8,988       8,105  
Revenue passenger miles (in thousands) (13)
    5,281,461       5,420,673       4,898,188       4,288,551       4,129,039  
Available seat miles (“ASMs”) (in thousands) (14)
    7,204,094       7,380,490       6,604,082       5,640,629       5,732,773  
Passenger load factor (15)
    73.3 %     73.4 %     74.2 %     76.0 %     72.0 %
Operating revenue per ASM (in cents) (2)
    11.74       11.72       11.92       14.62       14.68  
Operating revenue per block hour (2)
  $ 1,498     $ 1,451     $ 1,392     $ 1,987     $ 1,944  
Operating cost per ASM (in cents) (3)
    10.62       11.10       11.13       12.36       14.21  
Operating cost per block hour (3)
  $ 1,355     $ 1,375     $ 1,300     $ 1,679     $ 1,882  
Block hours
                                       
       Regional jets
    426,432       442,911       438,988       415,069       432,900  
       Turboprops
    138,166       152,890       126,675       -       -  
Departures
                                       
       Regional jets
    273,077       267,893       265,418       251,091       249,262  
       Turboprops
    110,568       121,635       107,171       -       -  
Average daily utilization (in block hours)
                                       
       Regional jets
    8.58       8.75       8.73       9.17       9.07  
       Turboprops
    7.84       7.86       7.32       -       -  
Average stage length (in miles)
    374       396       321       470       500  
Number of operating aircraft (end of period)
                                       
       Regional jets
    142       142       138       124       124  
       Turboprops
    48       51       47       -       -  
Employees
    5,106       5,644       5,316       3,860       3,436  
   
 
11.
We acquired Colgan on January 18, 2007. Data for 2007 includes Colgan data and statistics from the date of acquisition through the end of the year.
12.
Statistical results for the year ended December 31, 2008 were affected by the addition throughout the year of regional jets operated under the CRJ-900 DCA and turboprops operated under the Continental CPA.  As of December 31, 2008, Pinnacle operated 18 CRJ-900 aircraft under the CRJ-900 DCA (seven of which were the Temporary Aircraft), and Colgan operated 15 Q400 aircraft under the Continental CPA.
13.
Revenue passenger miles represent the number of miles flown by revenue passengers.
14.
Available seat miles represent the number of seats available for passengers multiplied by the number of miles the seats are flown.
15.
Passenger load factor equals revenue passenger miles divided by available seat miles.

 
28

 

Item 6.  Selected Financial Data

Certain Statistical Information:

The following tables present our operating expenses per block hour and operating expenses per available seat mile.  While not relevant to our financial results, this data is used as an analytic in the airline industry.  Please see Results of Operations in Item 7 of this Form 10-K for more information on our operating expenses.

   
Years Ended December 31,
   
2009
   
2008
   
2007
   
2006
   
2005
Operating expenses per block hour:
                           
    Salaries, wages and benefits
  $ 399     $ 369     $ 346     $ 329     $ 310
    Aircraft rentals
    214       216       245       636       642
    Ground handling services
    165       162       170       207       214
    Aircraft maintenance, materials and repairs
    174       157       159       83       74
    Other rentals and landing fees
    125       120       104       104       99
    Aircraft fuel
    39       83       68       263       260
    Commissions and passenger related expenses
    37       45       46       12       10
    Depreciation and amortization
    63       44       16       10       9
    Other
    135       156       146       140       126
    Provision for (decreases) increases in losses associated with bankruptcy filings of Northwest and Mesaba
    -       -       -       (105 )     138
    Impairment and aircraft retirement costs
    4       23       -       -       -
             Total operating expenses
  $ 1,355     $ 1,375     $ 1,300     $ 1,679     $ 1,882

   
Years Ended December 31,
   
2009
   
2008
   
2007
   
2006
   
2005
Operating expenses per available seat mile (in cents):
                           
    Salaries, wages and benefits
    3.12       2.98       2.97       2.43       2.34
    Aircraft rentals
    1.68       1.74       2.10       4.68       4.85
    Ground handling services
    1.29       1.31       1.46       1.53       1.62
Aircraft maintenance, materials and repairs
    1.36       1.26       1.36       0.61       0.56
    Other rentals and landing fees
    0.98       0.97       0.89       0.76       0.75
    Aircraft fuel
    0.31       0.67       0.58       1.93       1.96
    Commissions and passenger related expense
    0.29       0.37       0.39       0.09       0.07
    Depreciation and amortization
    0.49       0.36       0.14       0.07       0.07
    Other
    1.07       1.26       1.24       1.03       0.95
    Provision for (decreases) increases in losses associated with bankruptcy filings of Northwest and Mesaba
    -       -       -       (0.77 )     1.04
    Impairment and aircraft retirement costs
    0.03       0.18       -       -       -
             Total operating expenses
    10.62       11.10       11.13       12.36       14.21




Our results of operations improved substantially in 2009 as compared to 2008.  Our consolidated operating income improved by $35.1 million in 2009 as compared to 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’s pro-rate operations, and the restructuring of Colgan’s pro-rate operations.  Partially offsetting these improvements was a decline in unit revenue in Colgan’s pro-rate operations, and increased labor and maintenance costs throughout our 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 $15.4 million from this settlement.

In addition to improvements in our operating and net income, we 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”) could require us to repurchase them.  Holders of the Notes had 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, during 2009 we 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 spare rotable and expendable aircraft parts inventory and certain spare engines (the “Spare Parts Loan”).  In addition, we entered into a settlement agreement (the “ARS Settlement”) with the 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 $105.6 million during 2009, we 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 remained outstanding as of December 31, 2009.

In addition, we received a federal income tax refund in late February 2010 totaling approximately $38 million related to our 2009 federal income tax return.  Receipt of this refund further enhanced our liquidity position.  In January 2010, we completed a $10 million short-term credit facility collateralized by our federal income tax receivable.  This facility was designed to increase our working capital until we received our 2009 tax refund.  We repaid the facility in late February upon receipt of our tax refund.

Finally, in January 2010, we modified a financial covenant to maintain a certain level of unrestricted cash and cash equivalents contained in our Spare Parts Loan to lower the minimum requirement to $22.5 million for the first quarter of 2010 (for additional information regarding this minimum cash requirement test, please refer to Note 7 of our consolidated financial statements, which are contained in Item 8 of this Form 10-K).  As a result of these accomplishments, we had sufficient resources to repay the remaining outstanding $31.0 million par amount of Notes on the Put Date and meet our minimum cash requirement test.  As of February 16, 2010, and after repurchase of the Notes, we had consolidated unrestricted cash and cash equivalents of approximately $60 million, and we believe our liquidity will be adequate to fund our operations and meet our financial covenants for the foreseeable future.

There are several open disputed contractual issues, primarily related to our CRJ-200 ASA, between Delta and us.  Some of these issues date back to 2007, and we have been in discussions with Delta since that time in an attempt to reach resolution.  The current status of each issue is discussed in greater detail below.

First, Delta has challenged a one-time adjustment to our block hour, cycle and fixed payment rates under our CRJ-200 ASA that was to become effective January 1, 2006.  Niether party has ever applied a rate increase or rate decrease related to this provision under the CRJ-200 ASA, and we have received payments from Delta since 2006 as if there were no adjustment under this provision of the CRJ-200 ASA.  Based on the objection notice we received from Delta in 2007, the impact of Delta’s assertion could be a cumulative adjustment of as much as $11.0 million for 2006 through 2009, and a rate decrease of approximately $3.0 million annually until the next contractually scheduled rate adjustment on January 1, 2013.  We believe the rate adjustment, were it applicable, would result in an increase in our rates.  The parties have agreed to arbitrate this dispute if we are unable to successfully resolve this matter through further negotiation.

 
30

 
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview and Outlook (Continued)

Second, during 2009, Delta also disputed its obligation to fully reimburse us for aviation insurance premiums related to our Delta Connection operations.  During the second quarter of 2009, Delta requested that we exit the Delta aviation insurance program and independently source our own aviation insurance.  Effective July 1, 2009, we obtained our own independent insurance program at a cost significantly higher than what we were allocated by Delta under the Delta insurance program.  Delta has asserted that it is not obligated to reimburse the full costs of aviation insurance obtained under our independent insurance program related to our Delta Connection operations.  Since July, Delta has failed to reimburse us for $3.4 million of aviation insurance premiums related to our Delta Connection operations.  During the fourth quarter of 2009, we concluded that we did not meet the accounting standards to recognize future unreimbursed insurance premiums as revenue until we reach conclusion of this matter with Delta, and we did not recognize $1.7 million of unreimbursed insurance costs.  We firmly believe that our operating agreements with Delta require full reimbursement of our actual aviation insurance premiums related to Delta Connection operations, and we are evaluating our potential remedies related to this dispute.  We continue to discuss this matter with Delta, and we believe that the parties will resolve this issue in the near future.  To the extent that we are unable to successfully resolve this matter through discussion, we may be forced to take legal action to protect our contractual rights under our agreements with Delta.

Additionally, during 2009 Delta asserted that it may materially alter the payments related to the ground handling of our flights in the majority of the airports where we operate under our CRJ-200 ASA, resulting in a decrease in our annual operating income of approximately $1.1 million (subject to fluctuation based on changes in the level of our operations and the cities where we fly under the CRJ-200 ASA).  In August 2009, Delta began to apply its interpretation of ground handling to the monthly payments that Pinnacle received, resulting in a net reduction of payments to Pinnacle of approximately $0.4 million for August through December 2009.  In addition, Delta asserted that Pinnacle owed Delta a retroactive payment related to this ground handling issue of approximately $4 million.  In early 2010, in connection with the tentative settlement of several items, we tentatively agreed to accept Delta’s treatment of ground handling costs without any retroactive application prior to August 1, 2009.  We expect this change to reduce our operating income by approximately $1.1 million in 2010.

In connection with the resolution of our ground handling dispute, we also tentatively agreed to stipulate the amount owed to Delta under a provision of the CRJ-200 ASA associated with the sharing of Pinnacle’s overhead upon the establishment of a certain level of operations outside of the CRJ-200 ASA.  Under our tentative agreement, Delta will receive a rate reduction of $2.0 million for 2010 and $2.5 million for 2011, and $2.5 million for 2012 to satisfy this provision.  The parties also tentatively settled an outstanding dispute related to the change in aircraft livery of Pinnacle’s CRJ-200 fleet by Delta agreeing to reimburse us for these costs.  Finally, as part of the tentative agreement, Delta agreed to modify the payment terms of some of our airport related costs under certain circumstances, which will provide us some limited protection in the event that Delta asks us to operate in different markets in the future.  These matters, as well as resolution of our ground handling issue noted above, are subject to the execution of a binding written agreement, which the parties are in the process of preparing; however, no assurances can be given that additional modification to these and other arrangements will not occur in order to settle these matters with Delta.

Our pro-rate operations, which account for approximately 18% of our consolidated revenue, are susceptible to changes in passenger demand and fuel price volatility.  We took a number of steps during late 2008 and early 2009 to eliminate unprofitable markets, reduce costs, and increase revenue in our remaining pro-rate markets.  These steps and lower fuel prices have returned our pro-rate operations to profitability during 2009.  However, the airline industry is experiencing the effects of the current recessionary environment in the United States.  Industry passenger revenue declined dramatically during 2009, and our pro-rate operations were negatively affected by this drop.  While industry analysts forecast a recovery in passenger demand during 2010, we cannot predict whether there will be an increase in fares associated with our pro-rate operations in 2010.   In addition, in connection with the US Airways announcement of proposed reductions in service at LaGuardia, we discontinued our pro-rate operations at LaGuardia in early January 2010, reducing our operations under our US Airways agreement by four aircraft.  We are currently evaluating other markets and may enter new markets later in 2010.  If we do not identify profitable replacement markets for these aircraft, then our pro-rate revenue and profitability in 2010 will be materially affected by this reduction. 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 first quarter of 2010.

 
31

 
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview and Outlook (Continued)

During the fourth quarter of 2009, we relocated Colgan’s headquarters from Manassas, Virginia to Memphis, Tennessee.  We believe that relocating Colgan’s leadership team and system operations control center to our corporate 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 incurred approximately $1.1 million of costs associated with this move during 2009, and expect to incur additional costs of approximately $0.1 million during 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.  In early 2009 we 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 similarly sized 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 now 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.

 
32

 
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations


The following represents our results of operations, by segment and consolidated, for the year ended December 31, 2009.  A discussion of our results of operations as compared to the same periods in 2008 and 2007 follows.

   
Year Ended December 31, 2009
 
   
Pinnacle
   
Colgan
   
Consolidated
 
   
(in thousands)
 
Operating revenues
                 
Regional airline services
  $ 609,098     $ 227,151     $ 836,249  
Other
    8,839       420       9,259  
Total operating revenues
    617,937       227,571       845,508  
                         
Operating expenses
                       
Salaries, wages and benefits
    168,049       56,965       225,014  
Aircraft rentals
    116,768       3,980       120,748  
Ground handling services
    81,161       12,021       93,182  
Aircraft maintenance, materials and repairs
    59,630       38,445       98,075  
Other rentals and landing fees
    50,293       20,484       70,777  
Aircraft fuel
    -       22,110       22,110  
Commissions and passenger related expense
    3,818       17,101       20,919  
Depreciation and amortization
    20,247       15,152       35,399  
Other
    57,878       18,717       76,595  
Impairment and aircraft retirement charges
    -       1,980       1,980  
Total operating expenses
    557,844       206,955       764,799  
                         
Operating income
    60,093       20,616       80,709  
                         
Operating margin
    9.7 %     9.1 %     9.5 %
                         
Nonoperating income (expense)
                       
Interest income
                    1,947  
Interest expense
                    (44,862 )
Investment gain
                    3,877  
Miscellaneous income, net
                    567  
Total nonoperating expense
                    (38,471 )
Income before income taxes
                    42,238  
Income tax expense
                    (382 )
Net income
                  $ 41,856  

The following discussion provides an analysis of our results of operations and reasons for material changes therein for the year ended December 31, 2009 compared to the same periods in 2008 and 2007.  The acquisition of Colgan was completed on January 18, 2007 and Colgan’s 2007 data includes the period from the acquisition date through December 31, 2007, which represents approximately 94% of that year.

 
33

 
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations


Consolidated

   
Years Ended December 31,
 
   
2009
   
% Change
2009 -2008
   
2008
(Restated)
   
% Change
2008 - 2007
   
2007
(Restated)
 
Total operating revenue
  $ 845,508       (2 )%   $ 864,785       10 %   $ 787,374  
Total operating expenses
    764,799       (7 )%     819,178       11 %     734,963  
Operating income
    80,709       77 %     45,607       (13 ) %     52,411  
Operating margin
    9.5 %             5.3 %             6.7 %
                                         
Total nonoperating expense
    (38,471 )     (29 )%     (54,196 )     540 %     (8,462 )
                                         
Income (loss) before income taxes
    42,238       (592 )%     (8,589 )     (120 ) %     43,949  
Income tax expense
    (382 )     (84 )%     (2,408 )     (82 ) %     (13,526 )
Net income (loss)
  $ 41,856       (481 )%   $ (10,997 )     (136 ) %   $ 30,423  

2009 Compared to 2008

The following summarizes the nonrecurring items affecting our results for the years ended December 31, 2009 and 2008 (in thousands):

   
Years Ended December 31,
   
2009
   
2008
   
Pre-tax
   
After Tax
   
Pre-tax
   
After Tax
Impairment and aircraft retirement charges
  $ 1,980     $ 1,219     $ 13,548     $ 8,688
Excess of property insurance proceeds over cost basis of aircraft
    (835 )     (514 )     -       -
Net investment (gain) loss
    (3,877 )     (3,713 )     16,800       16,091
Ineffective portion of hedge
    1,424       877       -       -
Reversal of interest on tax reserves
    (2,926 )     (1,843 )     -       -
Gain on debt extinguishment
    (1,856 )     (1,118 )     -       -
IRS settlement
    -       (13,551 )     -       -
Total nonrecurring (gains) charges
  $ (6,090 )   $ (18,643 )   $ 30,348     $ 24,779

Several nonrecurring items affected both operating and nonoperating expense in 2009.  During 2009, we recorded a net increase to operating expense related to $2.0 million ($1.2 million net of tax) of return costs associated with the retirement of our Beech 1900 aircraft fleet, partially offset by the $0.8 million ($0.5 million net of tax) excess of insurance proceeds received over the cost basis of an aircraft that was destroyed.  These items cumulatively reduced operating income by $1.2 million for the year ended December 31, 2009.

During 2009, we recorded a net nonoperating gain of $3.9 million ($3.7 million net of tax) primarily related to the sale of our auction rate securities (“ARS”) portfolio.  Our net income for 2009 also includes net nonoperating gains of $0.2 million associated with the repurchase of certain indebtedness in the first quarter of 2009 and hedge losses associated with one Q400 aircraft that was destroyed.  Our net income for the year ended December 31, 2009 was also increased by $15.4 million related to our settlement with the Internal Revenue Service on its examination of our federal tax returns for the tax years 2003 through 2005.

 
34

 
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Consolidated and Segmented Results of Operations (Continued)

During 2008, we recorded charges of $13.5 million ($8.7 million net of tax) related to the impairment of Colgan’s goodwill and certain charges necessary to retire several of Colgan’s aircraft associated with its pro-rate operations.  In addition, during 2008, we recorded an impairment charge of $16.8 million ($16.4 million net of tax) to write down the value of our portfolio of auction rate securities to fair value.

Operating Revenues

Operating revenue of $845.5 million for the year ended December 31, 2009 decreased $19.3 million, or 2%, compared to 2008.  Changes in our capacity purchase related operating revenue are primarily caused by changes in our operating fleet size and aircraft utilization.  Changes in our pro-rate related operating revenue are primarily caused by a reduction in the scope of our pro-rate operations that we undertook in the fall of 2008, and by changes in the average load factor, average passenger fare, and average incentive payments we receive from our partners and under our Essential Air Service agreements.  These changes are discussed in greater detail within our segmented results of operations.

Operating Expenses

Operating expenses decreased by $54.4 million, or 7%, as compared to 2008, primarily due to the decrease in fuel expense and gallons consumed at our Colgan subsidiary, along with the impairment of Colgan’s goodwill and other intangible assets during 2008.  This change and others are discussed in greater detail within our segmented results of operations.

Nonoperating Expense

Net nonoperating expense of $38.5 million for the year ended December 31, 2009 decreased by approximately $15.7 million as compared to 2008.  The decrease is primarily related to the previously discussed $3.9 million net investment gain, as compared to the $16.8 million ARS impairment charge recorded during 2008.  Interest expense increased slightly, primarily related to the addition of CRJ-900 and Q400 aircraft to our fleet throughout 2008, offset by the reversal of interest on tax reserves, as previously discussed, and by a reduction in interest expense on our senior convertible notes as a result of the repurchase and retirement of the majority of those obligations during 2009.  The overall decrease was offset by a decrease in interest income of $4.9 million due to the decrease in interest rates on our ARS portfolio, as well as the sale of our ARS portfolio in August 2009.

Income Tax Expense
 
For the year ended December 31, 2009, we recorded income tax expense of $0.4 million.  As previously discussed, we recently reached settlement with the IRS regarding our examination for tax years 2003 through 2005. The IRS had proposed a number of adjustments to our returns totaling approximately $35.0 million of additional tax, plus accrued interest and penalties on these proposed adjustments.  We agreed to pay approximately $3 million of additional income tax and accrued interest in settlement of all open tax matters for the years examined.  As a result, we recorded a reduction to income tax expense of $13.6 million to reduce our accrued income tax reserves pursuant to the settlement.
 

 
35

 
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Consolidated and Segmented Results of Operations (Continued)

2008 Compared to 2007

Operating Revenue

Operating revenue of $864.8 million for the year ended December 31, 2008 increased $77.4 million, or 10%, over the year ended December 31, 2007.  This increase was primarily related to an increase in our capacity purchase revenue.  During 2008, we added 15 Q400 aircraft and 17 CRJ-900 aircraft, including seven CRJ-900 aircraft owned by Delta and operated by us on a temporary basis, to our operating fleet.   This was partially offset by a 7% decrease in the average number of CRJ-200 aircraft we operate under our CRJ-200 ASA.  Our pro-rate revenue increased slightly as a result of a 12% increase in average fare, offset by an 8% decrease in passengers.  These changes are discussed in greater detail within our segmented results of operations.

Operating Expenses

Operating expenses increased by $84.2 million, or 11%, during the year ended December 31, 2008, primarily due to increases in block hours and departures associated with the growth in our operating fleet.  In addition, operating expenses increased as a result of increased fuel prices related to our pro-rate operations, increased depreciation expense following the addition of our recently purchased CRJ-900 and Q400 aircraft, increased unreimbursed maintenance costs incurred on our aging CRJ-200 fleet, impairment charges primarily related to Colgan’s goodwill, Colgan’s lease return costs, and increased compensation expense resulting from the addition of employees to support the growth of our business.  These changes are discussed in greater detail within our segmented results of operations.

Nonoperating Expense

Net nonoperating expense of $54.2 million for the year ended December 31, 2008 increased by approximately $45.7 million over net nonoperating expense of $8.5 million during 2007.  This increase is attributable to the $28.6 million increase in interest expense, primarily related to the financing of the CRJ-900 and Q400 aircraft, the majority of which were delivered and financed during 2008.  Interest income decreased by $4.7 million, due to a lower average invested balance throughout 2008 as compared to 2007.  In addition, we recorded a $16.8 million impairment charge related to the decline in the fair values of our ARS portfolio.  Net nonoperating expense for the year ended December 31, 2007 was affected by a $4.1 million loss related to the sale of our remaining Northwest unsecured claim.

Income Tax Expense

For the year ended December 31, 2008, our income tax expense decreased by $11.1 million, primarily related to the decrease in pre-tax income as compared to 2007.  Partially offsetting the decline of income tax expense is the valuation allowance we recorded against the tax benefit related to the $16.8 million ARS impairment charge. This valuation allowance was recorded because the loss cannot offset ordinary income, and we expect no capital gains during the carryforward period of this loss.

 
36

 
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Consolidated and Segmented Results of Operations (Continued)

Pinnacle Operating Statistics

 
Years Ended December 31,
 
 
2009
   
% Change
 2009 - 2008
   
2008
   
% Change
2008 - 2007
   
2007
 
Revenue passengers (in thousands)
  10,771       4 %     10,393       4 %     9,996  
Revenue passenger miles (“RPMs”) (in thousands)
  4,640,392       (4 )%     4,844,526       5 %     4,620,861  
Available seat miles (“ASMs”) (in  thousands)
  6,108,609       (3 )%     6,320,269       5 %     6,004,680  
Passenger load factor
  76.0 %  
(0.7) pts.
      76.7 %  
(0.3) pts.
      77.0 %
Operating revenue per ASM (in cents)
  10.12       4 %     9.70       (2 )%     9.91  
Operating cost per ASM (in cents)
  9.13       3 %     8.85       (1 )%     8.95  
Operating revenue per block hour
$ 1,449       5 %   $ 1,384       2 %   $ 1,355  
Operating cost per block hour
$ 1,308       4 %   $ 1,263       3 %   $ 1,224  
Block hours
  426,432       (4 )%     442,911       1 %     438,988  
Departures
  273,077       2 %     267,893       1 %     265,418  
Average daily utilization (block hours)
  8.58       (2 )%     8.75       1 %     8.73  
Average stage length (miles)
  426       (7 )%     460       1 %     455  
Number of operating aircraft (end of period)
                                     
    CRJ-200
  126       2 %     124       (9 ) %     137  
    CRJ-900
  16       (11 )%     18 (1)     1,700 %     1  
Employees (end of period)
  3,675       (13 )%     4,204       5 %     4,008  
(1)  
On October 1, 2008, we entered into an agreement with Delta to operate on a short-term basis seven additional CRJ-900 aircraft (the “Temporary Aircraft”).  The Temporary Aircraft were returned in early 2009.

Pinnacle Operating Revenues

   
Years Ended December 31,
 
   
2009
   
% Change
2009 - 2008
   
2008
   
% Change
2008 - 2007
   
2007
 
Operating Revenues
                             
    Regional airline services
                             
        CRJ-200
  $ 540,939       (5 )%   $ 569,020       (2 )%   $ 583,591  
        CRJ-900
    68,159       94 %     35,146       2,268 %     1,484  
    Other
    8,839       (1 )%     8,923       (10 )%     9,894  
Total operating revenues
  $ 617,937       1 %   $ 613,089       3 %   $ 594,969  

2009 Compared to 2008

Regional Airline Services

For the year ended December 31, 2009, revenue earned under our CRJ-200 ASA of $540.9 million decreased by $28.1 million, or 5%, compared to 2008. Revenue earned under our CRJ-200 ASA was reduced by the return of 13 CRJ-200 aircraft throughout 2008 pursuant to the terms of our CRJ-200 ASA.  During the year ended December 31, 2009, we operated 3% fewer average CRJ-200 aircraft than 2008.  Compounding the reduction in our operating fleet size, we experienced declines in aircraft utilization.  As a result of both the reduction in our CRJ-200 fleet size and the decline in aircraft utilization, volume based revenue decreased by $22.3 million, or 6%, during 2009, as compared to 2008.

 
37

 
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Consolidated and Segmented Results of Operations (Continued)

We recorded $8.9 million less in departure based revenue during 2009, as compared to 2008, as a result of  a dispute with Delta over the amount that we earn for each departure under the CRJ-200 ASA.  Delta asserted that it has the right under the CRJ-200 ASA to reduce both the revenue we receive and the cost we pay for ground handling services in certain cities where Delta or its designee provides ground handling services to us.  During 2009, Delta began to compensate us according to its interpretation of the CRJ-200 ASA.  As a result, the revenue we received for the year ended December 31, 2009, related to certain ground handling services was reduced by approximately $8.9 million, and our related ground handling costs were reduced by $8.1 million, with the resulting net effect of a reduction of operating income of approximately $0.8 million. 

Lastly, a change in other reimbursable expenses caused revenue to increase by $1.2 million, for the year ended December 31, 2009, as compared to 2008.  Pursuant to the terms of our CRJ-200 ASA with Delta, we are reimbursed with margin for certain operational costs.  These costs include certain maintenance costs, aircraft rentals, passenger liability and hull insurance, property taxes, fuel, ground handling at CRJ-200 ASA service cities, and landing fees at Detroit Metropolitan Wayne County Airport (“DTW”).  To the extent that these reimbursable costs increase or decline, we experience a corresponding increase or decline in revenue.  Revenue from reimbursable expenses increased by $5.8 million related to heavy maintenance checks, $1.6 million related to increased deicing expense, $3.8 million related to increased insurance expenses, and $0.6 million related to other maintenance expense.  These increases were offset by a decrease of $4.1 million related to reduced property taxes, $2.6 million related to reduced engine maintenance expense, and $3.9 million related to reduced aircraft rental expense.

Revenue earned under the CRJ-900 DCA was $68.2 million for the year ended December 31, 2009, an increase of $33.0 million, or 94%, as compared to 2008.  During the year ended December 31, 2009, on average we operated 86% more CRJ-900 aircraft than in 2008.

Other Revenue

Other revenue decreased $0.8 million, or 1%, for the year ended December 31, 2009, as compared to 2008.  This decrease was primarily related to a decline in revenue earned from providing baggage handling services to Delta at its Memphis hub, offset by an increase in third party ground handling revenue related to new third party ground handling contracts that we entered into during 2009.

2008 Compared to 2007

Regional Airline Services

For the year ended December 31, 2008, revenue earned under our CRJ-200 ASA of $569.0 million decreased by $14.6 million, or 2%, as compared to 2007.  Revenue earned under our CRJ-200 ASA was negatively affected by the return of 15 CRJ-200 aircraft pursuant to the terms of our CRJ-200 ASA.  During the year ended December 31, 2008, on average we operated 7% fewer CRJ-200 aircraft as compared to 2007.  In addition, revenue was negatively affected by a decline in the amount of our reimbursable costs.    Our reimbursable expenses for the year ended December 31, 2008 decreased by 5%, causing decreases in revenue of 7%.  Partially offsetting this decrease is a 4% increase in CRJ-200 ASA revenue for the year ended December 31, 2008 related to the annual inflation index adjustment in our CRJ-200 block hour and departure ASA rates.

Revenue earned under our CRJ-900 DCA was approximately $35.1 million for the year ended December 31, 2008.  As of December 31, 2008, we operated 18 CRJ-900 aircraft under our CRJ-900 DCA, seven of which were operated on a short-term basis until the Company’s seven remaining permanent aircraft entered service.  We took delivery of three CRJ-900 aircraft in late December 2008 that were placed into service in January 2009.  During the year ended December 31, 2007, we operated one CRJ-900 for one month under the CRJ-900 DCA.

 
38

 
 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Consolidated and Segmented Results of Operations (Continued)

Other Revenue

Other revenue decreased $1.0 million, or 10%, for the year ended December 31, 2008, as compared to 2007.  This decrease is primarily related to a decrease in the amount of ground handling we provided to third party vendors, including Northwest, during 2008.

Pinnacle Operating Expenses

   
Years Ended December 31,
 
   
2009
   
% Change
2009 - 2008
   
2008
   
% Change
2008 - 2007
   
2007
 
Operating expenses
                             
Salaries, wages and benefits
  $ 168,049       2 %   $ 164,775       10 %   $ 150,205  
Aircraft rentals
    116,768       (3 )%     120,932       (7 )%     130,181  
Ground handling services
    81,161       (3 )%     83,336       (1 )%     84,215  
Aircraft maintenance, materials and repairs
    59,630       21 %     49,238       0 %     49,047  
Other rentals and landing fees
    50,293       (5 )%     52,994       8 %     49,005  
Commissions and passenger related expense
    3,818       (38 )%     6,160       11 %     5,545  
Depreciation and amortization
    20,247       52 %     13,346       190 %     4,609  
Other
    57,878       (16 )%     68,691       6 %     64,698  
Total operating expenses
    557,844       (0 )%     559,472       4 %     537,505  
                                         
Operating income
  $ 60,093       12 %   $ 53,617       (7 )%   $ 57,464  
                                         
Operating margin
    9.7 %  
1.0 pts.
      8.7 %  
(1.0) pts.
      9.7 %

2009 Compared to 2008

Salaries, wages and benefits increased by $3.3 million, or 2%, for the year ended December 31, 2009 as compared to 2008.  This increase is largely attributable to rising health care and insurance costs, which increased approximately $3.8 million in 2009, as compared to 2008.  Wages increased slightly, as wage rates increased for existing employees, while headcount decreased, primarily related to reductions in ground handling personnel in stations where we performed our own ground handling functions under the CRJ-200 ASA.  The reduction in ground handling personnel occurred as a result of Delta reassigning ground handling functions to itself or its designees.  Wage rate increases were also offset by a $1.4 million reduction in the matching contribution of Pinnacle’s non-pilot 401(k) plan.  During 2009, the matching contribution was temporarily suspended.

Aircraft rental expense decreased $4.2 million, or 3%, for the year ended December 31, 2009 as compared to 2008.  This decrease relates to a decrease of 3% in the average number of CRJ-200 aircraft, which are leased from Delta, operated during 2009 as compared to 2008.  As previously discussed, aircraft rentals are reimbursable expenses under our CRJ-200 ASA, and as a result of the fewer average number of CRJ-200 aircraft in our fleet, revenue under our CRJ-200 ASA decreased by $3.9 million for the year ended December 31, 2009.

Ground handling services decreased by $2.2 million, or 3%, during the year ended December 31, 2009, as compared to 2008.  Although this change is nominal, there were large changes in the mix of reimbursed and unreimbursed ground handling expense.  These changes caused significant decreases in regional airlines services revenue.

 
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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Consolidated and Segmented Results of Operations (Continued)

Aircraft maintenance, materials and repairs expenses increased $10.4 million, or 21%, for the year ended December 31, 2009 as compared to 2008.  This increase is attributable to additional maintenance related to the aging of our CRJ-200 fleet as the majority of our CRJ-200 aircraft are no longer covered under warranty.  We are also incurring additional mainte