Attached files

file filename
EX-10.80 - EXHIBIT 10.80 SECOND AMENDED AND RESTATED ASA - PINNACLE AIRLINES CORPex10-80.htm
EX-10.81 - EXHIBIT 10.81 FIRST AMENDMENT TO DELTA CONNECTION AGREEMENT - PINNACLE AIRLINES CORPex10-81.htm
EX-10.79 - EXHIBIT 10.79 SECOND AMENDMENT TO CIT CREDIT AGREEMENT - PINNACLE AIRLINES CORPex10-79.htm
EX-32 - EXHIBIT 32 - PINNACLE AIRLINES CORPex32.htm
EX-31.2 - EXHIBIT 31.2 - PINNACLE AIRLINES CORPex31-2.htm
EX-31.1 - EXHIBIT 31.1 - PINNACLE AIRLINES CORPex31-1.htm
EX-10.86 - EXHIBIT 10.86 SECURITY AND PLEDGE AGREEMENT - PINNACLE AIRLINES CORPex10-86.htm
EX-10.85 - EXHIBIT 10.85 PROMISSORY NOTE - PINNACLE AIRLINES CORPex10-85.htm
EX-10.84 - EXHIBIT 10.84 STOCK PURCHASE AGREEMENT - PINNACLE AIRLINES CORPex10-84.htm
EX-10.82 - EXHIBIT 10.82 CRJ-900 DELTA CONNECTION AGREEMENT - PINNACLE AIRLINES CORPex10-82.htm
EX-10.83 - EXHIBIT 10.83 SAAB 340B+ DELTA CONNECTION AGREEMENT - PINNACLE AIRLINES CORPex10-83.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q

x
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended September 30, 2010
 
or
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from__________ to__________

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

Delaware
(State or other jurisdiction
of incorporation or organization)
03-0376558
(I.R.S. Employer
Identification No.)
   
1689 Nonconnah Blvd, Suite 111
Memphis, Tennessee
(Address of principal executive offices)
 
 38132
(Zip Code)
 
901-348-4100
(Registrant's telephone number, including area code)

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

Yes ¨
 
No x

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

Yes ¨
 
No ¨

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

Large accelerated filer ¨
Accelerated filer ¨
   
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

As of November 9, 2010, 18,572,519 shares of common stock were outstanding.
 
 

 

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


 
2

 

Part 1.  Financial Information

Item 1.  Financial Statements

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

   
Three Months Ended September 30,
 
   
2010
   
2009
 
             
Operating revenues
           
Regional airline services
  $ 297,197     $ 214,478  
Other
    5,138       2,730  
Total operating revenues
    302,335       217,208  
Operating expenses
               
Salaries, wages and benefits
    92,199       55,402  
Aircraft rentals
    34,000       30,093  
Ground handling services
    27,528       21,964  
Aircraft maintenance, materials and repairs
    39,198       25,311  
Other rentals and landing fees
    24,219       17,659  
Aircraft fuel
    6,814       6,197  
Commissions and passenger related expense
    6,466       5,660  
Depreciation and amortization
    10,293       9,377  
Other
    35,899       21,749  
Total operating expenses
    276,616       193,412  
                 
Operating income
    25,719       23,796  
                 
Operating income as a percentage of operating revenues
    8.5 %     11.0 %
Nonoperating (expense) income
               
Interest expense, net
    (10,693 )     (11,712 )
Miscellaneous income, net
    357       4,334  
Total nonoperating expense
    (10,336 )     (7,378 )
Income before income taxes
    15,383       16,418  
Income tax expense
    (5,942 )     (5,041 )
Net income
  $ 9,441     $ 11,377  
                 
Basic earnings per share
  $ 0.52     $ 0.63  
                 
Diluted earnings per share
  $ 0.51     $ 0.62  
                 
Shares used in computing basic earnings per share
    18,137       17,970  
Shares used in computing diluted earnings per share
    18,392       18,204  

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

 
3

 

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

   
Nine Months Ended September 30,
 
   
2010
   
2009
 
             
Operating revenues
           
Regional airline services
  $ 717,530     $ 629,614  
Other
    11,605       6,679  
Total operating revenues
    729,135       636,293  
Operating expenses
               
Salaries, wages and benefits
    207,377       167,999  
Aircraft rentals
    94,055       90,679  
Ground handling services
    75,291       70,622  
Aircraft maintenance, materials and repairs
    92,814       76,780  
Other rentals and landing fees
    57,542       53,987  
Aircraft fuel
    19,234       15,968  
Commissions and passenger related expense
    16,090       15,714  
Depreciation and amortization
    27,927       26,740  
Other
    80,621       54,890  
Total operating expenses
    670,951       573,379  
                 
Operating income
    58,184       62,914  
                 
Operating income as a percentage of operating revenues
    8.0 %     9.9 %
Nonoperating (expense) income
               
Interest expense, net
    (29,294 )     (32,770 )
Miscellaneous (expense) income, net
    (922 )     4,389  
Total nonoperating expense
    (30,216 )     (28,381 )
Income before income taxes
    27,968       34,533  
Income tax (expense) benefit
    (10,948 )     1,680  
Net income
  $ 17,020     $ 36,213  
                 
Basic earnings per share
  $ 0.94     $ 2.02  
                 
Diluted earnings per share
  $ 0.92     $ 2.01  
                 
Shares used in computing basic earnings per share
    18,121       17,968  
Shares used in computing diluted earnings per share
    18,433       18,050  

The accompanying notes are an integral part of these condensed consolidated financial statements.
 
 
4

 

Pinnacle Airlines Corp.
(in thousands, except share data)
             
   
September 30, 2010
   
December 31, 2009
 
Assets
 
(Unaudited)
       
Current assets
           
Cash and cash equivalents
  $ 126,729     $ 91,574  
Restricted cash
    8,018       3,115  
Receivables, net
    43,021       34,518  
Spare parts and supplies, net
    34,879       19,472  
Prepaid expenses and other assets
    7,594       3,508  
Assets held for sale
    -       1,255  
Deferred income taxes, net of allowance
    10,141       10,406  
Income taxes receivable
    3,966       40,803  
Total current assets
    234,348       204,651  
Property and equipment
               
Flight equipment
    848,622       755,236  
Aircraft pre-delivery payments
    38,981       12,049  
Other property and equipment
    66,132       48,710  
Less accumulated depreciation
    (112,792 )     (86,501 )
Net property and equipment
    840,943       729,494  
                 
Investments
    1,709       2,723  
Debt issuance costs, net
    4,421       3,561  
Goodwill
    25,339       18,422  
Intangible assets, net
    16,066       12,586  
Other assets, primarily insurance receivables
    317,880       317,659  
Total assets
  $ 1,440,706     $ 1,289,096  
                 
Liabilities and stockholders’ equity
               
Current liabilities
               
Current maturities of long-term debt
  $ 51,132     $ 36,085  
Senior convertible notes
    -       30,596  
Pre-delivery payment facility
    30,552       2,027  
Accounts payable
    50,598       23,982  
Deferred revenue
    26,530       24,363  
Accrued expenses and other current liabilities
    98,309       60,610  
Total current liabilities
    257,121       177,663  
Noncurrent pre-delivery payment facility
    -       4,910  
Long-term debt, less current maturities
    577,255       519,234  
Deferred revenue, net of current portion
    166,860       177,711  
Deferred income taxes
    26,495       13,532  
Other liabilities
    290,236       293,809  
                 
Commitments and contingencies
               
                 
Stockholders’ equity
               
     Common stock, $0.01 par value; 40,000,000 shares authorized;
23,065,846 and 22,786,743 shares issued, respectively
    231       228  
     Treasury stock, at cost, 4,493,327 and 4,450,092 shares, respectively
    (68,479 )     (68,152 )
     Additional paid-in capital
    123,900       121,513  
     Accumulated other comprehensive loss
    (13,012 )     (14,431 )
     Retained earnings
    80,099       63,079  
Total stockholders’ equity
    122,739       102,237  
Total liabilities and stockholders’ equity
  $ 1,440,706     $ 1,289,096  

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

 
5

 

Pinnacle Airlines Corp.
(in thousands)

   
Nine Months Ended September 30,
 
   
2010
   
2009
 
             
Operating activities
           
  Net income
  $ 17,020     $ 36,213  
  Adjustments to reconcile net income to cash provided by operating activities:
               
    Depreciation and amortization
    32,260       31,097  
    Interest accretion, net
    383       5,704  
    Deferred income taxes
    12,475       47,694  
    Recognition of deferred revenue
    (17,185 )     (17,400 )
    Other
    5,498       1,872  
    Changes in operating assets and liabilities:
               
             Restricted cash
    (4,113 )     1,259  
             Receivables
    9,605       (1,867 )
             Prepaid expenses and other assets
    (11,195 )     (1,300 )
             Insurance proceeds
    1,364       3,127  
             Spare parts and supplies
    (4,457 )     (2,375 )
             Income taxes receivable (payable)
    36,837       (3,069 )
             Accounts payable and accrued expenses
    26,420       (5,813 )
             Change in uncertain income tax positions and related interest
    (535 )     (19,345 )
             Increase in deferred revenue
    -       8,185  
                      Cash provided by operating activities
    104,377       83,982  
Investing activities
               
  Purchases of property and equipment, net
    (7,425 )     (7,021 )
  Proceeds from sales of investments
    1,777       27,770  
  Aircraft pre-delivery payments
    (5,343 )     -  
  Proceeds from sales of Beech aircraft
    1,450       -  
  Acquisition of Mesaba Aviation, Inc.
    2,631          
  Insurance proceeds related to property and equipment
    -       3,576  
                  Cash (used in) provided by investing activities
    (6,910 )     24,325  
Financing activities
               
  Proceeds from debt
    10,000       24,761  
  Repurchase of senior convertible notes
    (30,979 )     (83,870 )
  Payments on debt and pre-delivery payment facilities
    (34,979 )     (23,358 )
  Payments on credit facilities
    (4,054 )     (12,875 )
  Payments on capital leases
    (1,543 )     (812 )
  Other financing activites
    (757 )     (411 )
                 Cash used in financing activities
    (62,312 )     (96,565 )
                 
Net increase in cash and cash equivalents
    35,155       11,742  
Cash and cash equivalents at beginning of period
    91,574       69,469  
Cash and cash equivalents at end of period
  $ 126,729     $ 81,211  
                 
Noncash investing and financing activities
               
 Property and equipment acquired through the issuance of debt
  $ 62,342     $ 49,511  
 Acquisition of Mesaba Aviation, Inc. funded by the issuance of debt
  $ 63,265     $ -  
 Debt retired with insurance proceeds
  $ -     $ 15,424  
 Debt retired with investment proceeds
  $ -     $ 90,000  

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

 
6

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





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

Pinnacle operates an all-regional jet fleet and provides regional airline capacity to Delta Air Lines, Inc. and its subsidiaries (“Delta”) as a Delta Connection carrier at its hub airports in Atlanta, Detroit, Memphis, and Minneapolis/St. Paul.  At September 30, 2010, Pinnacle operated 126 Canadair Regional Jet (“CRJ”)-200 aircraft with 662 daily departures to 117 cities in 33 states, the District of Columbia and four Canadian provinces.  Pinnacle also operated a fleet of 16 CRJ-900 aircraft as a Delta Connection carrier from Delta’s global hub in Atlanta with 79 daily departures to 22 cities in 13 states, the District of Columbia, Belize, Mexico, and two Canadian provinces.

Mesaba provides regional airline capacity to Delta as a Delta Connection carrier at its hub airports in Atlanta, Detroit, Memphis, Minneapolis/St. Paul, and Salt Lake City under three capacity purchase agreements.  At September 30, 2010, Mesaba operated 41 CRJ-900 aircraft, providing 184 daily departures to 59 cities in 34 states.  In addition, Mesaba operated 19 CRJ-200 aircraft, providing 97 daily departures to 37 cities in 16 states.  Mesaba also operated 32 Saab 340 B+ aircraft, providing 159 daily departures to 42 cities in 15 states.

Colgan operates an all-turboprop fleet under a regional airline capacity purchase agreement with Continental Airlines, Inc. (“Continental”), and also under revenue pro-rate agreements with Continental, United Air Lines, Inc. (“United”) and US Airways Group, Inc. (“US Airways”).  Colgan’s operations are focused primarily in the northeastern United States and Texas.  As of September 30, 2010, Colgan had 223 daily departures to 42 destinations in ten states and the District of Columbia within its pro-rate operations.  Colgan operated 13 Saab 340 aircraft as a Continental Connection carrier from Continental’s hub airport in Houston, 11 Saab 340 aircraft as a United Express carrier at Washington/Dulles, and ten Saab 340 aircraft as a US Airways Express carrier in Boston and New York City.  Colgan also operated 16 Bombardier Q400 aircraft as a Continental Connection carrier, providing 87 daily departures to 15 cities in 11 states, the District of Columbia and three Canadian provinces, under a capacity purchase agreement with Continental at its hub at Newark Liberty International Airport.  On October 1, 2010, Continental and United completed their previously announced merger, creating the world’s largest airline company.  The two airlines will ultimately operate under the United brand, and the Company’s Continental Connection operations will be transitioned to the United Express brand.

These interim condensed consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States, the instructions to Quarterly Report on Form 10-Q and Rule 10-01 of Regulation S-X, and should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (including normal recurring adjustments) necessary to present fairly the Company's consolidated financial position, the results of its operations, and its cash flows for the periods indicated herein.  Operating results for the periods presented are not necessarily indicative of the results that may be expected for the year ended December 31, 2010.

 
7

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

 
All amounts contained in the notes to the condensed consolidated financial statements are presented in thousands, with the exception of years, per share amounts and number of aircraft.  Certain reclassifications have been made to conform prior year financial information to the current period presentation.

For the three and nine months ended September 30, 2010, the Company has considered subsequent events through the date its condensed consolidated financial statements were filed with the Securities and Exchange Commission on Form 10-Q.

New Accounting Standards.  In September 2009, the Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force (“EITF”) reached final consensus on Issue 08-1, Revenue Arrangements with Multiple Deliverables, or Issue 08-1, which will update Accounting Standards Codification (“ASC”) 605, Revenue Recognition, and changes the accounting for certain revenue arrangements. The new requirements change the allocation methods used in determining how to account for multiple payment streams and will result in the ability to separately account for more deliverables, and potentially less revenue deferrals. Additionally, Issue 08-1 requires enhanced disclosures in financial statements. Issue 08-1 is effective for revenue arrangements entered into or materially modified in fiscal years beginning after June 15, 2010 on a prospective basis, with early application permitted. The Company is currently evaluating the impact this Issue will have on its consolidated financial statements.

In June 2009, the FASB issued Statement of Financial Accounting Standard (“SFAS”) No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140, which amends FASB ASC 860, Transfers and Servicing.  This guidance requires more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. This guidance is effective for financial asset transfers occurring after the beginning of an entity’s first fiscal year beginning after November 15, 2009 (calendar year 2010). The Company adopted this guidance on January 1, 2010.  The application of the requirements of this guidance did not have a material effect on the accompanying condensed consolidated financial statements.


The Company’s operating contracts fall under two categories: capacity purchase agreements and revenue pro-rate agreements.  The Company’s pro-rate agreements are primarily modified pro-rate agreements, as they are designed to maintain a base level of revenue.  The following is a summary of the percentage of regional airline services revenue attributable to each contract type and code-share partner for the three and nine months ended September 30, 2010.

   
Three Months Ended September 30, 2010
   
Percentage of Regional Airline Service Revenue
       
Pro-Rate Agreements
   
Source of Revenue
 
Capacity Purchase
Agreements
 
Standard
 
Modified
 
Total
Delta
 
78%
 
-
 
-
 
78%
Continental(1)
 
7%
 
-
 
5%
 
12%
United(1)
 
-
 
-
 
4%
 
4%
US Airways
 
-
 
4%
 
-
 
4%
Essential Air Service
 
-
 
-
 
2%
 
2%
     Total
 
85%
 
4%
 
11%
 
100%


 
8

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

 
   
Nine Months Ended September 30, 2010
   
Percentage of Regional Airline Service Revenue
       
Pro-Rate Agreements
   
Source of Revenue
 
Capacity Purchase
Agreements
 
Standard
 
Modified
 
Total
Delta
 
76%
 
-
 
-
 
76%
Continental(1)
 
8%
 
-
 
6%
 
14%
United(1)
 
-
 
-
 
5%
 
5%
US Airways
 
-
 
3%
 
-
 
3%
Essential Air Service
 
-
 
-
 
2%
 
2%
     Total
 
84%
 
3%
 
13%
 
100%

(1)
On October 1, 2010, United and Continental completed their merger.  Both carriers will continue to operate separately until receipt of a single operating certificate.


On July 1, 2010, the Company entered into a Stock Purchase Agreement (the “Stock Purchase Agreement”) with Delta and Mesaba pursuant to which the Company purchased all of the issued and outstanding common stock of Mesaba from Delta (the “Acquisition”). The condensed consolidated financial statements reported herein contain Mesaba’s operating results since the acquisition date.

The Company is accounting for the Acquisition in accordance with FASB ASC Topic 805, Business Combinations, whereby the purchase price paid is allocated to the tangible and identifiable intangible assets acquired and liabilities assumed from Mesaba based on their estimated fair values as of the closing date.   The Company is still in the process of obtaining information to evaluate the acquisition-date fair value of the consideration transferred to Delta, the assets acquired, and the liabilities assumed.  This process will likely be completed during the fourth quarter of 2010.

The total acquisition-date fair value of consideration transferred to Delta was $75,013.  This amount is comprised of: 1) a promissory note of $63,265, which is secured by certain equipment of and all of the capital stock in Mesaba, pursuant to a security and pledge agreement (the “Promissory Note”); 2) a $5,000 payment owed to Delta (paid in October 2010); and 3) $6,748 representing the cancellation of amounts owed to the Company by Delta relating to the reimbursement of past aviation insurance premiums.  The Promissory Note has an interest rate of 12.5%, with the principal payable in equal quarterly installments of $3,163 beginning on October 15, 2010 and a final maturity date of July 15, 2015.  Payments under the Promissory Note may be made by deductions from amounts due to the Company under all of the Company’s operating agreements with Delta.  The Promissory Note contains customary covenants and representations, including a covenant to maintain a minimum amount of cash and cash equivalents at the end of each month.

During the second half of 2009, Delta began disputing its obligation to fully reimburse Pinnacle for its aviation insurance premiums under both the CRJ-200 ASA and the CRJ-900 DCA.  In connection with the Acquisition, the Company and Delta signed an agreement whereby, beginning July 1, 2010, all amounts pertaining to aviation insurance premiums under the CRJ-200 ASA and the CRJ-900 DCA will be reimbursed in full.  The cumulative reimbursement shortfall of approximately $6,748 from July 1, 2009 through June 30, 2010 was resolved in conjunction with the Acquisition.  As this amount was realized in connection with entering into new and amended long-term revenue contracts with Delta, $5,000, which is the amount in excess of the $1,748 receivable previously recorded by Pinnacle, will be deferred and recognized as revenue over 12 years, which is the life of the Mesaba contractual cash flows.


 
9

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

 

The following table represents the preliminary allocation of the total consideration of $75,013 to tangible and intangible assets acquired and liabilities assumed:

   
Purchase Price Allocation
 
Current assets, including cash of $2,631
  $ 38,132  
Property and equipment
    64,400  
Intangible assets
    5,000  
Goodwill
    6,917  
     Total assets acquired
    114,449  
        Less: Accounts payable
    (5,334 )
                  Accrued expenses
    (27,898 )
                  Other liabilities
    (6,204 )
Assets acquired less liabilities assumed
  $ 75,013  

The difference between the purchase price and the fair value of Mesaba’s tangible and intangible assets acquired and liabilities assumed was recorded as goodwill.  The $6,917 in goodwill has been fully allocated to Mesaba, which is presented as a new operating segment of the Company in Note 11, Segment Reporting.  The Company attributes this goodwill to the opportunity to expand its regional airline services and its relationship with Delta as well as the synergies that will be created by operating similar fleet types out of overlapping hub locations.  The entire goodwill balance from the Acquisition will be deductible for tax purposes.

The following table summarizes the identifiable intangible assets acquired in the Acquisition:
 
   
Gross
Carrying
Amount
   
Accumulated
Amortization at
September 30, 2010
   
Weighted Average
Amortization Period
(in years)
   
Amortization Through
 September 30, 2010
   
Estimated Amortization
 through
December 31, 2010
 
Non-compete agreement(1)
  $ 500     $ 125       1.0     $ 125     $ 250  
CRJ-200 ASA(2)
    2,000       67       7.5       67       133  
CRJ-900 DCA(3)
    2,500       52       12.0       52       104  
     Total
  $ 5,000     $ 244       9.1     $ 244     $ 487  
 
(1)
The non-compete agreement will be amortized into operating expenses from July 1, 2010 through June 30, 2011.
(2)
The CRJ-200 ASA customer contract will be amortized as increases to revenue from July 1, 2010 through December 31, 2017.
(3)
The CRJ-900 DCA customer contract will be amortized as increases to revenue from July 1, 2010 through June 30, 2022.
 
The Company also recognized a liability of $3,500 in relation to the Saab 340B+ DCA, which the Company determined to be a below market rate contract that will be amortized as increases to revenue during the two year life of the contract, through June 30, 2012.  For the three months ended September 30, 2010, the Company amortized $438 into revenue, which also represents the accumulated amortization balance at September 30, 2010.  The estimated amortization for the twelve months ended December 31, 2010 is $875.
 
 
10

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

 
 
The estimated net amortization on the amortizable intangibles, including the below market rate Saab DCA contract, for each of the five succeeding fiscal years and thereafter is presented in the table below:

   
(Increase) / Decrease
to Operating Income
 
2011
  $ (1,025 )
2012
    (400 )
2013
    475  
2014
    475  
2015
    475  
Thereafter, through 2022
    1,888  
Total future net amortization
  $ 1,888  

The Company has included operating revenues from Mesaba of $71,535 and operating income of $3,065 for the period from July 1, 2010 to September 30, 2010.  During the three and nine months ended September 30, 2010, the Company incurred transaction costs of $858 and $1,503, respectively, related to the Acquisition.  These costs have been recognized in operating expense within the consolidated statements of income.
 
The following unaudited pro forma combined results of operations give effect to the Acquisition as if it had occurred at the beginning of the period presented. The terms of Mesaba’s capacity purchase agreements entered into concurrently with the Acquisition have been retroactively applied to the beginning of the periods presented.  The unaudited pro forma combined results of operations do not purport to represent the Company’s consolidated results of operations had the Acquisition occurred on the dates assumed, nor are these results necessarily indicative of the Company’s future consolidated results of operations. The Company expects to realize significant benefits from integrating Mesaba’s operations into its existing operations. The unaudited pro forma combined results of operations do not reflect these benefits or costs.

   
Nine Months Ended
September 30, 2010
   
Nine Months Ended
September 30, 2009(1)
 
             
Operating revenues
  $ 860,958     $ 900,956  
Operating income
    63,827       82,849  
Net income
    17,857       44,068  
Basic and diluted earnings per share
  $ 0.97     $ 2.44  
 
(1)
 
During the nine months ended September 30, 2009, Mesaba generated additional income by providing ground handling services to various third parties, most of which were related parties.  This line of business, which typically generated high margins, ended in September 2009.  Although this ground handling business was not acquired, the operating revenues, operating income and net income earned from providing these services are included in the nine months ended September 30, 2009 pro forma information above.
 
In connection with the Acquisition, the Company and Delta entered into an amendment and restatement of Pinnacle’s capacity purchase agreement under which it operates 126 CRJ-200 aircraft as a Delta Connection carrier (the “CRJ-200 ASA”) to add the operation of Mesaba’s fleet of CRJ-200 aircraft to the agreement, which terminates on December 31, 2017.  The Company and Delta also entered into an amendment of Pinnacle’s capacity purchase agreement under which it operates 16 CRJ-900 aircraft as a Delta Connection carrier (the “CRJ-900 DCA”), primarily to conform certain operating performance metrics with new standards established by the Company and Delta related to the combined fleet of Pinnacle’s and Mesaba’s CRJ-900 aircraft.  The Company and Delta also entered into a new Delta Connection Agreement regarding the operation of Mesaba’s CRJ-900 aircraft for Delta (the “Mesaba CRJ-900 DCA”), and a new Delta Connection Agreement regarding the operation of Mesaba’s SAAB 340B+ aircraft for Delta (the “Saab DCA”).  All of the Company’s capacity purchase agreements with Delta contain cross-default provisions.  These cross-default provisions are not effective until July 1, 2011.  The Promissory Note with Delta also contains cross-default provisions to each capacity purchase agreement, effective July 1, 2010.

The Mesaba CRJ-900 DCA provides that the Company and its subsidiaries will operate Mesaba’s fleet of 41 CRJ-900 aircraft as a Delta Connection carrier through June 30, 2022.  The Company will be paid rates and reimbursed certain expenses related to its provision of regional airline services to Delta, similar to its existing agreements with Delta.  The Mesaba CRJ-900 DCA also contains operating performance targets upon which the Company may earn an additional incentive or pay a penalty to Delta.  In addition, the Mesaba CRJ-900 DCA contains various rate resets, including a comprehensive rate reset to be effective January 1, 2013.

 
11

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

 
 
The Saab DCA provides that Mesaba will operate its existing fleet of Saab 340B+ aircraft as a Delta Connection carrier for varying terms through June 30, 2012.  The Saab aircraft will be retired from service over the next two years and returned to Delta on an “as is, where is” basis, with no continuing obligation by the Company.  Similar to the Mesaba CRJ-900 DCA, the Saab DCA provides for the Company to receive rates and be reimbursed certain expenses while the Company is operating the Saab fleet, with annual reconciliations of certain rates to the Company’s actual costs to provide regional airline services under the Saab DCA.  The Saab DCA also contains operating performance targets, with incentives for exceeding targets and penalty payments for performance below the targets.

Mesaba and Delta also entered into a facilities use agreement for Delta to license a back-up operational facility to Mesaba for two years following closing.  Additionally, Mesaba and Delta entered into a transition services agreement for Mesaba to provide information technology, finance, and human resource administrative services to a subsidiary of Delta for one year following the closing date of the Acquisition.  Finally, Mesaba and Delta also entered into a mutual release agreement, which terminated most operating agreements previously in place between the parties.


The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2010 and 2009:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net income
  $ 9,441     $ 11,377     $ 17,020     $ 36,213  
                                 
Basic earnings per share
  $ 0.52     $ 0.63     $ 0.94     $ 2.02  
                                 
Diluted earnings per share
  $ 0.51     $ 0.62     $ 0.92     $ 2.01  
                                 
Share computation:
                               
Weighted average number of shares outstanding for basic earnings per share
    18,137       17,970       18,121       17,968  
Share-based compensation (1)
    255       234       312       82  
Weighted average number of shares outstanding for diluted earnings per share
    18,392       18,204       18,433       18,050  

(1)
During the three months ended September 30, 2010 and 2009, options to acquire 1,548 and 1,094 shares, respectively, were excluded from the computation of diluted EPS as their impact was anti-dilutive. During the nine months ended September 30, 2010 and 2009, options to acquire 1,338 and 1,684 shares, respectively, were excluded from the computation of diluted EPS as their impact was anti-dilutive.
 
 
12

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



The components of comprehensive income, net of related taxes, for the three and nine months ended September 30, 2010 and 2009 are as follows:
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net income
  $ 9,441     $ 11,377     $ 17,020     $ 36,213  
Adjustments:
                               
Amortization of unrealized actuarial gain
    (4 )     (136 )     (11 )     (149 )
Change in cash flow hedge unrealized loss
    471       494       1,430       2,405  
Reversal of unrealized gain on investments
    -       (4,404 )     -       -  
Total comprehensive income
  $ 9,908     $ 7,331     $ 18,439     $ 38,469  


The Company invests excess cash balances primarily in short-term money market instruments and overnight repurchase agreements.  

Prior to August 2009, the Company’s investment portfolio consisted primarily of auction rate securities (“ARS”).  In August 2009, the Company reached an agreement to sell its portfolio of ARS to the financial institution that originally sold the ARS portfolio to the Company (the “ARS Settlement”).   The ARS Settlement provides that for a period of three years from the date of the ARS Settlement, the Company shall have the right to repurchase all or a portion of the ARS at the same discount to par the bank paid to the Company under the ARS Settlement (the “ARS Call Options”).  During the three months ended September 30, 2009, the Company determined the initial fair value of the ARS Call Options and the corresponding gain from the ARS Settlement to be $4,078.

During the three and nine months ended September 30, 2010, upon redemption of certain ARS by the issuer at par, the Company exercised a portion of the ARS Call Options and received net cash proceeds of $1,387 and $1,777, respectively, and recorded a realized gain of $81 and $395, respectively.  The Company determined the fair value of the ARS Call Options to be $1,709 and $2,723 at September 30, 2010 and December 31, 2009, respectively.  They are classified as investments on the Company’s condensed consolidated balance sheets.
 
The fair values of the ARS Call Options were estimated using a discounted cash flow model.  The model considered potential changes in yields for securities with similar characteristics to the underlying ARS and evaluated possible future refinancing opportunities for the issuers of the ARS.  The analysis then assessed the likelihood that the options would be exercisable as a result of the underlying ARS being redeemed or traded in a secondary market at an amount greater than the exercise price prior to the end of the option term.  Future changes in the fair values of the ARS Call Options will be marked-to-market through the condensed consolidated statement of income.   The Company has determined that its ARS Call Options are classified in Level 3 of the fair value hierarchy.  During the three and nine months ended September 30, 2010, the Company recorded an unrealized gain of $428 and a net unrealized gain of $368, respectively, to adjust the ARS Call Options to their fair values.
 
As discussed in Note 8, Hedging Activities, the Company utilizes aircraft fuel call options and options to purchase forward interest rate swaps (“Swaptions”) in order to manage its commodity price risk and interest rate risk, respectively.

 
13

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

 

        The valuations of these instruments are determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative.  The Company has classified its derivatives in Level 2 of the fair value hierarchy, as the significant inputs to the overall valuations are based on market-observable data or information derived from or corroborated by market-observable data, including market-based inputs to models, model calibration to market-clearing transactions, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency. Where models are used, the selection of a particular model to value a derivative depends upon the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. The Company uses similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices, yield curves, credit curves, measures of volatility, and correlations of such inputs.  For the Company’s derivatives, all of which trade in liquid markets, model inputs can generally be verified and model selection does not involve significant management judgment.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by its counterparties. For counterparties with publicly available credit information, the credit spreads over LIBOR used in the calculations represent implied credit default swap spreads obtained from a third party credit data provider.  However, as of September 30, 2010, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

The tables below present the Company’s assets and liabilities measured at fair value as of September 30, 2010, aggregated by the level in the fair value hierarchy within which those measurements fall.

   
Level 1
   
Level 2
   
Level 3
   
Balance at
September 30, 2010
 
Assets
                       
Aircraft fuel call options (1)
  $ -     $ 6     $ -     $ 6  
Interest rate Swaptions (1)
  $ -     $ 13     $ -     $ 13  
ARS Call Options
  $ -     $ -     $ 1,709     $ 1,709  
 
(1)  
For additional discussion and description of these assets, refer to Note 8, Hedging Activities.
 
 
14

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

 
The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3):
 
   
Asset
 
   
ARS Call Options
 
   
Nine Months Ended September 30,
 
     2010      2009  
Balance at beginning of period
  $ 2,723     $ -  
Transfers to Level 3
    -       -  
Total unrealized gains (losses)
               
    Included in nonoperating expense
    (299 )     -  
Realized gains on redemptions, included in nonoperating expense(1)
    216       -  
Net proceeds from redemptions (2)
    (271 )     -  
Balance at March 31
  $ 2,369     $ -  
                 
Transfers to Level 3
    -       -  
Total unrealized gains (losses)
               
    Included in nonoperating expense
    239       -  
Realized gains on redemptions, included in nonoperating expense(1)
    98       -  
Net proceeds from redemptions (2)
    (119 )     -  
Balance at June 30
  $ 2,587     $ -  
                 
Transfers to Level 3
    -       4,078  
Total unrealized gains (losses)
               
    Included in nonoperating expense
    428       -  
Realized gains on redemptions, included in nonoperating expense(1)
    81       -  
Net proceeds from redemptions (2)
    (1,387 )     -  
Balance at September 30
  $ 1,709     $ 4,078  
 
(1)
 
The Company determines the cost basis for ARS redemptions using the specific identification method.
(2)
 
Partial redemption of securities at par by the issuer.
(3)
 
Proceeds received from the sale of the ARS portfolio in connection with the ARS Settlement.
 
 
15

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


 
   
Asset
 
   
Auction Rate Securities
 
   
Nine Months Ended September 30,
 
    2010      2009  
Balance at beginning of period
  $ -     $ 116,900  
Transfer to Level 3
    -       -  
Total unrealized gains (losses)
               
    Included in nonoperating expense
    -       -  
    Included in other comprehensive income (“OCI”)
    -       -  
Realized gains on redemptions, included in nonoperating expense(1)
    -       44  
Interest accretion
    -       438  
Redemptions (2)
    -       (2,700 )
Balance at March 31
  $ -     $ 114,682  
Transfers to Level 3
    -       -  
Total unrealized gains (losses)
               
    Included in nonoperating expense
    -       (966 )
    Included in OCI
    -       4,598  
Realized gains on redemptions, included in nonoperating expense(1)
    -       632  
Interest accretion
    -       437  
Redemptions (2)
    -       (2,950 )
Balance at June 30
  $ -     $ 116,433  
Transfers to Level 3
    -       -  
Total unrealized gains (losses)
               
    Included in nonoperating expense
    -       155  
    Included in OCI
    -       (4,598 )
Realized gains on redemptions, included in nonoperating expense(1)
    -       -  
Interest accretion
    -       130  
Redemptions (2)
    -       (800 )
Sales(3)
            (111,320 )
Balance at September 30
  $ -     $ -  
                 
 
(1)
 
The Company determines the cost basis for ARS redemptions using the specific identification method.
(2)
 
Partial redemption of securities at par by the issuer.
(3)
 
Proceeds received from the sale of the ARS portfolio in connection with the ARS Settlement.
 
The carrying amounts and estimated fair values of the Company’s borrowings, which are discussed in detail in Note 7, Borrowings, were as follows:

   
As of September 30, 2010
   
As of December 31, 2009
 
   
Carrying Amount
   
Estimated Fair Value
   
Carrying Amount
   
Estimated Fair Value
 
Long-term notes payable, primarily related to owned aircraft
  $ 628,387     $ 556,418     $ 555,319     $ 482,161  
Pre-delivery payment facilities
    30,552       30,552       6,937       6,937  
Senior convertible notes
    -       -       30,596       29,779  

These estimates were based on either market prices or the discounted amount of future cash flows using the Company’s current incremental rate of borrowing for similar liabilities.

 
16

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



Senior Convertible Notes

In February 2005, the Company completed the private placement of $121,000 principal amount of 3.25% senior convertible notes due February 15, 2025 (the "Notes").  If certain conditions were met, the Notes were convertible into a combination of cash and common stock equivalent to the value of 75.6475 shares of the Company’s common stock per $1 par amount of Notes, or a conversion price of $13.22 per share.   During 2009, the Company repurchased $90,021 par value of the Notes for $83,870 plus accrued and unpaid interest.  The book value of that portion of the Notes at the dates of the repurchase was $85,293.  As of December 31, 2009, $30,979 par amount of Notes was outstanding.

On February 15, 2010, the holders of the Notes exercised their option to require the Company to purchase all of the remaining outstanding Notes for cash at a purchase price equal to 100% of their principal amount plus accrued interest. As of September 30, 2010, $0 par amount of the Notes was outstanding.

The unamortized discount of the liability component of the Notes was $383 at December 31, 2009.  This discount was amortized through February 15, 2010.  The fair value of the Notes as of December 31, 2009 was $29,779.

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

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Effective interest rate on liability component
    -       13.5 %     13.5 %     13.5 %
Interest cost recognized as amortization of the discount of liability component
  $ -     $ 1,841     $ 383     $ 6,708  
Cash interest cost recognized (coupon interest)
  $ -     $ 662     $ 126     $ 2,440  

Long-Term Notes Payable

As of September 30, 2010 and December 31, 2009, the Company had long-term notes payable of $628,387 and $555,319, respectively.

Included in long-term notes payable are borrowings from Export Development Canada (“EDC”) for owned aircraft.  The borrowings are collateralized by the Company’s fleet of CRJ-900 and Q400 aircraft and bear interest at rates ranging between 3.8% and 6.7% with maturities through 2025.  Amounts outstanding under these EDC borrowings were $528,583 and $513,462 at September 30, 2010 and December 31, 2009, respectively.

During 2009, the Company completed a $25,000, three-year term loan financing with C.I.T Leasing and funded by CIT Bank (the “Spare Parts Loan”). The Spare Parts Loan is secured by Pinnacle’s and Colgan’s pool of spare repairable, rotable and expendable parts and certain aircraft engines.  The interest rate for the Spare Parts Loan is a variable rate, which is indexed to LIBOR (subject to a floor) and was 8.5% as of December 31, 2009.  During August 2010, the Company and CIT amended the Spare Parts Loan to reduce the interest rate floor to 8.0%, to extend the maturity date until June 30, 2014, to provide for additional borrowings of up to $4,500, and to provide for a prepayment penalty under certain circumstances.  As of September 30, 2010, the interest rate on the Spare Parts Loan was 8.0%.  The Spare Parts Loan requires that the Company maintain a minimum liquidity level at the end of every month. The Spare Parts Loan also has standard provisions relating to the Company’s obligation to timely repay the indebtedness and maintenance of the collateral base relative to the outstanding principal amount of the borrowing.  As of September 30, 2010 and December 31, 2009, amounts outstanding under the Spare Parts Loan were $22,575 and $24,215, respectively.  During October 2010, the Company drew an additional $1,630, increasing total borrowings under the Spare Parts Loan. The proceeds are being used to finance the initial provisioning of rotable aircraft parts to support the Company’s Q400 aircraft purchases and general working capital purposes.

 
17

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

 
7.  Borrowings (continued)
 
On July 1, 2010, the Company completed the Acquisition of Mesaba.  The Acquisition was financed under the Promissory Note, which had a balance of $63,265 as of September 30, 2010.  See Note 3, Acquisition of Mesaba, for more details about the Promissory Note.

Pre-delivery Payment Financing Facilities

In January 2009, the Company amended its Continental CPA to operate an additional 15 Q400 aircraft.  The aircraft began delivering in July 2010 and will continue delivery through April 2011.  In connection with this amendment, the Company executed a new pre-delivery payment (“PDP”) financing facility with EDC for up to $35,600 on substantially similar terms to its previous PDP facilities.  This instrument has an interest rate indexed to LIBOR, which was 3.19% as of September 30, 2010.  Amounts outstanding under this facility were $30,552 and $6,937 at September 30, 2010 and December 31, 2009, respectively.

Bridge Loan

On January 13, 2010, the Company entered into a short-term loan agreement with a bank for $10,000 (the “Bridge Loan”).  The Bridge Loan was secured by the Company’s anticipated 2009 federal income tax refund and had an effective interest rate of 4.5%.  The Bridge Loan was designed to temporarily provide the Company with additional working capital until it received its 2009 federal income tax refund.  The Company repaid the Bridge Loan in full upon receipt of the 2009 federal income tax refund of approximately $38,000 in late February 2010.


The Company is exposed to certain risks arising from both its business operations and economic conditions.  As part of the Company’s overall risk management strategy, the Company utilizes financial derivative instruments to minimize exposure to unplanned decreases in earnings and cash flows that could be caused by volatility in aircraft fuel and interest rates.  Financial derivative instruments that are used as part of the Company’s risk management strategy include aircraft fuel call options, interest rate Swaptions, and interest rate swaps.  The use of these derivative financial instruments is consistent with the Company’s risk management objective to mitigate exposure to the variability of future cash flows attributable to potential increases relating to volatility in aircraft fuel prices and interest rates on the anticipated issuance of fixed-rate debt.  The Company does not hold or issue any derivative financial instruments for speculative or trading purposes.

Aircraft Fuel Call Options

As a result of the Company’s pro-rate code-share agreements with Continental, US Airways and United, the Company is exposed to aircraft fuel price risk. The Company purchases aircraft fuel in quantities expected to be used in a reasonable period of time in the normal course of business.  To mitigate the financial risk associated with short-term changes in aircraft fuel prices, the Company initiated an aircraft fuel hedging program in April 2010, using aircraft fuel call options to manage the price risk associated with forecasted purchases of aircraft fuel utilized in the Company’s operations.

The Company does not purchase aircraft fuel call options for trading purposes and is not applying hedge accounting as of September 30, 2010.  Therefore, these options are recorded at their fair value in the Company’s condensed consolidated balance sheet, and any subsequent increases or decreases in their fair value are recorded in the condensed consolidated statement of income until their expiration.  
 
At September 30, 2010, the Company had outstanding fuel call options covering approximately 85% of its expected fuel requirements from October through December 2010.  These options have an average strike price of $2.68 per gallon, providing financial protection if fuel prices exceed this level in any given month.  The Company may purchase additional fuel call options in the future to help mitigate risk associated with potential increases in aircraft fuel prices. During the three and nine months ended September 30, 2010, the Company recorded expenses of $41 and $380, respectively, in aircraft fuel expense related to fuel call options.  The Company had fuel call options with a fair value of $6 at September 30, 2010, which are included in prepaid expenses and other assets on the Company’s condensed consolidated balance sheet.

 
18

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

 
 
Interest Rate Swaptions

The Company is exposed to interest rate risk from the time of entering into purchase commitments until the delivery of Q400 aircraft, occurring between July 2010 and April 2011, throughout which time the Company will receive permanent, fixed-rate financing.  To mitigate the financial risk associated with changes in long-term interest rates, the Company commenced an interest rate hedging program in April 2010, utilizing options to purchase forward interest rate swaps.  These Swaptions provide a hedge for the expected interest payments associated with anticipated future issuances of long-term, fixed-rate debt to finance the Company’s firm future Q400 aircraft deliveries.  Interest rate Swaptions give the purchaser the right to enter into a swap at a future date if the strike rate of the Swaption is more favorable than the current market swap rate.

The Company does not purchase interest rate Swaptions for trading purposes and is not applying hedge accounting as of September 30, 2010.  The Company records these interest rate Swaptions at their fair value on its condensed consolidated balance sheet, and subsequent increases and decreases in their fair value are recorded in the condensed consolidated statement of income until their expiration.

At September 30, 2010, the Company had 13 outstanding Swaptions to hedge the Company’s risk related to increases in interest rates applicable to approximately $230,000 of debt the Company expects to borrow.  The average capped rate for the Swaptions approximates 6.77%.  If actual fixed rates exceed the capped rates, the Company will exercise its option contracts and receive one-time cash payments based on the market value of the interest rate option contracts when the Q400 aircraft are delivered to the Company.  If the actual fixed rate is less than the applicable hedged fixed rate at the time of delivery, then each Swaption contract will expire unexercised.  During the three and nine months ended September 30, 2010, the Company recorded expense of $170 and $1,625, respectively, related to the change in fair value of its interest rate Swaptions.  These costs are classified as miscellaneous nonoperating expense on the Company’s condensed consolidated statements of income.  The Company had interest rate Swaptions with a fair value of $13 at September 30, 2010, which are included in prepaid expenses and other assets on the Company’s condensed consolidated balance sheet.

Interest Rate Swaps

To manage long-term interest rate risk for the fixed-rate debt issued in 2008 associated with aircraft the Company received and placed into service in 2008, the Company initiated a cash flow hedging program in 2007.  The hedging program utilized forward-starting interest rate swaps, which hedged the expected interest payments associated with issuances of long-term debt to finance the aircraft.   The Company had no unsettled swaps associated with this hedging program at September 30, 2010 or December 31, 2009.

These interest rate swaps were designated as cash flow hedges and the permanent financing was secured in 2008.  The remaining hedge-related balance, which is included in accumulated other comprehensive loss, is being amortized into interest expense over the life of the aircraft financing.  The losses from settled interest rate swaps recorded in other comprehensive income (“OCI”), net of tax, within the condensed consolidated balance sheets were $13,428 and $14,858 as of September 30, 2010 and December 31, 2009, respectively.  Included in the total net realized losses from interest rate swaps as of September 30, 2010 are $2,848 in unrecognized losses that are expected to be reclassified from OCI into earnings during the 12 months following September 30, 2010.

 
19

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

 
 
The tables below present the effect of the Company’s interest rate swaps on the condensed consolidated statements of operations for the three and nine months ended September 30, 2010 and 2009:

Three Months Ended
September 30,
 
Amount of Loss Reclassified
from OCI into Income
(Effective Portion) (2)
   
Amount of Loss Recognized
in Income on Derivative (Ineffective Portion and
Amount Excluded from Effectiveness Testing)
 
2010
  $ (737 )   $ -  
2009
  $ (774 )   $ -  

Nine Months Ended
September 30,
 
Amount of Loss Reclassified
from OCI into Income
(Effective Portion) (2)
   
Amount of Loss Recognized
in Income on Derivative (Ineffective Portion and
Amount Excluded from Effectiveness Testing)
 
2010
  $ (2,239 )   $ -  
2009
  $ (2,372 )   $ (1,424 )(1)
 
(1)
This charge is related to the debt that financed the Q400 aircraft that was destroyed in an accident during the three months ended March 31, 2009.  The associated debt was repaid during the three months ended March 31, 2009.  This loss is included in miscellaneous nonoperating expense in the Company’s condensed consolidated statement of income for the three months ended March 31, 2009.
(2)
Derivatives classified as cash flow hedges include interest rate swaps.  Amounts reclassified from OCI into income are recorded in interest expense within the Company’s condensed consolidated statements of income.


The following summarizes the significant components of the Company’s income tax expense for the periods indicated:

   
Three Months Ended September 30,
 
   
2010
   
2009
 
   
Dollars
   
Percent
   
Dollars
   
Percent
 
Income tax expense at statutory rate
  $ (5,384 )     (35.0 )%   $ (5,746 )     (35.0 )%
State income taxes, net of federal taxes
    (438 )     (2.9 )%     (534 )     (3.2 )%
Settlements
    462       3.0 %     -       -  
Tax-exempt income
    -       -       71       0.4 %
Meals and entertainment
    (496 )     (3.2 )%     (146 )     (0.9 )%
Valuation allowance
    (59 )     (0.4 )%     1,248       7.6 %
Other
    (27 )     (0.1 )%     66       0.4 %
Income tax expense
  $ (5,942 )     (38.6 )%   $ (5,041 )     (30.7 )%

   
Nine Months Ended September 30,
 
   
2010
   
2009
 
   
Dollars
   
Percent
   
Dollars
   
Percent
 
Income tax expense at statutory rate
  $ (9,789 )     (35.0 )%   $ (12,087 )     (35.0 )%
State income taxes, net of federal taxes
    (758 )     (2.7 )%     (816 )     (2.4 )%
Settlements
    462       1.7 %     13,401       38.8 %
Tax-exempt income
    -       -       290       0.9 %
Meals and entertainment
    (726 )     (2.6 )%     (391 )     (1.1 )%
Valuation allowance
    (126 )     (0.5 )%     1,377       4.0 %
Other
    (11 )     (0.0 )%     (94 )     (0.3 )%
Income tax (expense) benefit
  $ (10,948 )     (39.1 )%   $ 1,680       4.9 %


 
20

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

 
9. Income Taxes (continued)
 
The Company provides for interest and penalties accrued related to unrecognized tax benefits in nonoperating expenses.  As of September 30, 2010 and December 31, 2009, the Company had $252 and $325 of accrued interest and penalties, respectively.

The Company had $85 and $547 of unrecognized tax benefits at September 30, 2010 and December 31, 2009.  The amount of unrecognized tax benefits that would affect the Company’s effective tax rate if recognized was $85 as of September 30, 2010.  

During the three months ended September 30, 2010, the Internal Revenue Service (the “Service”) completed its audit of the Company’s federal income tax returns for calendar years 2006 and 2008.  These years have been settled with no change to taxable income.  As a result, the Company recognized $462 as a discrete income tax benefit for the quarter and $97 as interest income.  Due to the fact that the Company filed an amended federal tax return for the 2007 fiscal year, the Service has not yet completed its audit of the Company’s tax return for that year.

During the three months ended March 31, 2009, the Company reached an agreement with the Service to resolve certain matters related to the Service’s examination of the Company’s federal income tax returns for calendar years 2003, 2004, and 2005.  The Company and the Service agreed for the Company to pay approximately $3,000 of additional income tax and accrued interest in settlement of all open tax matters for these years.  With this agreement, the Service completed its examination of the Company’s federal tax filings for 2003, 2004, and 2005.  As a result of the completion of this examination, the Company recorded during the three months ended March 31, 2009 a reduction to income tax expense of $13,552 and a pre-tax reduction to interest expense of $2,926.


Employees. The Company operates under several collective bargaining agreements with groups of its employees, as outlined in the table below. 

Employee Group
 
Employees Represented
 
Representing Union
 
Contract Amendable Date
Pinnacle’s pilots
    1,173  
Air Line Pilots Association
 
April 30, 2005
Mesaba’s pilots
    948  
Air Line Pilots Association
 
May 31, 2012
Colgan’s pilots
    507  
Air Line Pilots Association
 
Pending (1)
Pinnacle’s flight attendants
    732  
United Steel Workers of America
 
February 1, 2011
Mesaba’s flight attendants
    586  
Association of Flight Attendants
 
May 31, 2012
Colgan’s flight attendants
    257  
United Steel Workers of America
 
April 30, 2014 (2)
Pinnacle’s ground operations agents
    954  
United Steel Workers of America
 
May 23, 2015
Pinnacle’s flight dispatchers
    60  
Transport Workers Union of America
 
December 31, 2013
Mesaba’s flight dispatchers
    21  
Transport Workers Union of America
 
May 31, 2012
Mesaba’s mechanics
    328  
Aircraft Mechanics Fraternal Association
 
May 31, 2012
     Total unionized labor
    5,566        

(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.

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

In December 2008, Colgan’s pilots voted to select ALPA to represent them for purposes of negotiating a collective bargaining agreement with the Company.  It is too early in the negotiation process to determine the timing or financial impact of this collective bargaining agreement.

 
21

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

 
Subsequent to the Company’s acquisition of Mesaba, ALPA voluntarily agreed to negotiate for a single ALPA pilot contract that would replace individual collective bargaining agreements pertaining to each of Pinnacle, Mesaba, and Colgan.  Negotiations began during September 2010.  If the negotiating team is unable to reach a tentative agreement for a combined collective bargaining agreement, then separate negotiations will resume for Pinnacle and Colgan.  The contract between the Company and ALPA covering Mesaba’s pilots is not set to expire until May 2012.

On May 19, 2010, Pinnacle’s airport ground handling employees, who are represented by the United Steelworkers AFL-CIO, ratified a tentative agreement to amend their collective bargaining agreement with Pinnacle.

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

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

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

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

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

The Company has recorded a related liability of approximately $285,000 in other non-current liabilities on its consolidated balance sheet at September 30, 2010 related to potential claims associated with this accident.  This liability is offset in its entirety by a corresponding long-term receivable, recorded in other noncurrent assets on the condensed consolidated balance sheet that the Company expects to receive from insurance carriers as claims are resolved.  These estimates may be revised as additional information becomes available.

Settlement of Disputes with Code-share Partner.   On July 1, 2010, the Company and Delta reached agreement over a number of significant disputes, primarily related to the Company’s CRJ-200 ASA, that had arisen since 2007 and that were further discussed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

 
22

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

 
One disputed item related to a one-time adjustment to the Company’s block hour, cycle and fixed payment rates under the CRJ-200 ASA that was to become effective January 1, 2006.  Delta had asserted that the adjustment should have resulted in a significant decrease in the rates under the CRJ-200 ASA, of as much as $3,000 annually, with a cumulative adjustment of as much as $11,000 from 2006 through June 30, 2010.  The Company had asserted that the adjustment would have resulted in an increase in the CRJ-200 ASA rates of as much as $3,000 to $5,000 annually.  On July 1, 2010, the parties agreed to release each other from any claims related to this one-time adjustment, and the rates then in effect under the CRJ-200 ASA were not adjusted.

The Company and Delta also finalized a number of other matters under the CRJ-200 ASA upon which the parties previously had agreed verbally, including the resolution of a dispute related to ground handling revenue and expenses, aircraft paint reimbursements, overhead cost sharing, and adjustments to remove landing fees and air navigation fees from the Company’s fixed rates and convert these expenses into fully reimbursed costs.  None of these items had a material impact on the Company’s results of operations for the nine months ended September 30, 2010.


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

The Company’s three operating segments consist of its three subsidiaries, Pinnacle, Mesaba, and Colgan.  Mesaba is a new operating segment resulting from the Acquisition discussed in Note 3, Acquisition of Mesaba.  Corporate overhead expenses incurred by Pinnacle Airlines Corp. are allocated to the operating expenses of each subsidiary.

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

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Operating revenues:
                       
    Pinnacle
  $ 166,132     $ 155,253     $ 485,590     $ 465,177  
    Mesaba
    71,535       -       71,535       -  
    Colgan
    64,668       61,955       172,010       171,116  
    Consolidated
  $ 302,335     $ 217,208     $ 729,135     $ 636,293  
                                 
Operating income:
                               
    Pinnacle
  $ 16,529     $ 15,686     $ 48,006     $ 46,582  
    Mesaba
    3,065       -       3,065       -  
    Colgan
    6,125       8,110       7,113       16,332  
    Consolidated
  $ 25,719     $ 23,796     $ 58,184     $ 62,914  

The following represents the Company’s segment assets:

   
September 30, 2010
   
December 31, 2009
 
Total assets:
           
    Pinnacle
  $ 611,443     $ 616,339  
    Mesaba
    126,832       -  
    Colgan
    734,193       676,054  
    Intercompany
    (31,762 )     (3,297 )
    Consolidated
  $ 1,440,706     $ 1,289,096  



Forward-Looking Statements

Certain statements in this Current Report on Form 10-Q (or otherwise made by or on the behalf of Pinnacle Airlines Corp.) contain various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, 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 2, Management’s Discussion and Analysis of Results of Operations and Financial Condition under “Overview of Third Quarter 2010 Financial Results” and “Outlook”.  In light of these risks and uncertainties, and others not described in this Report, the forward-looking events discussed in this Report might not occur, might occur at a different time, or might cause effects of a different magnitude or direction than presently anticipated.

General

The following discussion and analysis by management describes the principal factors affecting the Company’s results of operations, liquidity, capital resources and contractual cash obligations.  This discussion should be read in conjunction with the accompanying unaudited condensed consolidated financial statements and our Annual Report on Form 10-K for the year ended December 31, 2009 (“Annual Report”), which include additional information about our business practices, significant accounting policies, risk factors, and the transactions that underlie our financial results.

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

Overview of Third Quarter 2010 Financial Results

On July 1, we acquired Mesaba Aviation, Inc. (“Mesaba”) from Delta Airlines, Inc. and its subsidiaries (“Delta”).  The acquisition of Mesaba had a profound impact on our third quarter 2010 financial results.  Our consolidated revenue increased by $71.5 million, or 31%, as a result of the acquisition.  Further, Mesaba reported operating income of $3.1 million.  Taking into account interest on a $63.3 million note that we issued to Delta as part of the acquisition (the “Promissory Note”), the Mesaba acquisition increased our pre-tax income by $1.0 million.

Our consolidated operating income in the third quarter was $25.7 million, an increase of $1.9 million as compared to the third quarter of 2009.  Pinnacle Airlines, Inc. (“Pinnacle”) reported operating income of $16.5 million, an increase of $0.8 million from the third quarter of 2009.  An increase in block hours and year-over-year rate increases under our contracts with Delta contributed to the improved operating income.  In addition, we reduced an estimate of penalties for the first half of 2010 under one of our contracts with Delta by $0.5 million.  Colgan Air, Inc. (“Colgan”) reported operating income of $6.1 million, a decrease of $2.0 million as compared to the third quarter of 2009.  Higher maintenance, labor and training costs primarily caused the drop in operating income, partially offset by unit revenue gains in our pro-rate operations.  The financial results of our operating segments are discussed in further detail below under “Results of Operations”.

 
24

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

 
Overview of Third Quarter 2010 Financial Results (continued)
 
We generated $59.6 million in cash from operations during the third quarter of 2010, and we ended the quarter with $126.7 million in cash and cash equivalents.  Operating cash flow was unusually high during the third quarter due to the acquisition of Mesaba and the timing of payments related to prepaid expenses, trade payables and accrued expenses.  Mesaba generated approximately $28 million in operating cash flow, inclusive of a build-up of negative working capital due to the terms of our contracts with Delta.  We generally receive payments weekly from Delta under the contracts covering Mesaba’s operations, yet we do not pay the majority of costs associated with our operations for as much as 30 days after we complete flights.  This resulted in a one-time increase in liquidity of approximately $10 million in the third quarter.  Mesaba also had a higher than expected working capital balance (as defined in the Stock Purchase Agreement with Delta) at July 1.  The Stock Purchase Agreement contains a neutral targeted working capital balance, with a reconciliation process if actual working capital as of July 1 was materially different from the target.  Mesaba had a positive working capital balance of $6.3 million as of July 1, which ultimately increased operating cash flow during the third quarter.   Pursuant to the reconciliation process outlined in the Stock Purchase Agreement, we reimbursed Delta $5.0 million in October 2010 and increased the amount of the Promissory Note by the remaining $1.3 million. 
 
The Company expects operating cash flow in the fourth quarter to be lower than the average achieved in the first three quarters of 2010, as prepaid expenses, trade payables and accrued expenses are expected to return to lower levels.  In addition, Management expects the balance of cash and cash equivalents to decline through April 2011 as the Company acquires new Q400 aircraft to operate under its capacity purchase agreement with United Continental Holdings, Inc.
 
Outlook

Mesaba Acquisition

We purchased Mesaba from Delta through the issuance to Delta of a Promissory Note totaling $63.3 million.  Mesaba operates a fleet of 41 CRJ-900 aircraft, 19 CRJ-200 aircraft, and 32 Saab 340B+ aircraft as a Delta Connection carrier, with hubs in Atlanta, Detroit, Memphis, Minneapolis/St. Paul, and Salt Lake City.  In connection with our acquisition of Mesaba, we entered into a new capacity purchase agreement with Delta providing for the operation of Mesaba’s CRJ-900 fleet for a period of 12 years (the “Mesaba CRJ-900 DCA”), and we modified our existing CRJ-200 airline services agreement (the “CRJ-200 ASA”) with Delta to include Mesaba’s fleet of CRJ-200 aircraft.  We also entered into a two-year capacity purchase agreement covering Mesaba’s fleet of 32 Saab 340 B+ aircraft (the “Saab DCA”).  Under these agreements, Delta will pay us rates and reimburse us certain direct expenses, similar to our existing capacity purchase agreements with Delta.  These agreements provide for targeted cash income (cash payments received from Delta less all expenses other than depreciation and amortization and interest expense, and less forecasted capital expenditures) of $18 million per year through July 2022.  Because these agreements contain rates that increase annually with inflation, we can earn more or less than $18 million of cash contract income in any given year depending on how our expenses fluctuate.  In addition, primarily because depreciation and amortization are generally excluded from reimbursement under these agreements, our reported operating income under generally accepted accounting principles related to Mesaba’s operations will differ from the $18 million target cash contract income.  These agreements also provide for certain rate resets, the first of which will occur effective January 1, 2013.  Under these rate resets, we will negotiate and agree with Delta on new rates based on a forecast of our projected cash expenditures under the agreements for the subsequent five-year period, inclusive of our targeted cash contract income of $18 million per year.  Finally, these agreements contain targets related to our operating performance, and we can earn additional incentives or incur performance penalties depending on our actual operating performance.  Because we will incur some integration costs during 2011 and 2012, we do not expect to realize the full $18 million targeted cash contract income during these years.  During the third quarter of 2010, Mesaba generated operating income of $3.1 million, which includes depreciation and amortization of $1.3 million.  These results are in line with our expectations and targets under our contracts with Delta.

Prior to selling Mesaba to us, Delta announced plans to retire Mesaba’s fleet of Saab 340B+ aircraft during 2011.  Accordingly, the Saab DCA provides for the wind-down of Mesaba’s Saab 340B+ operations over a period not to extend beyond June 2012.  Under the Saab 340 DCA, we do not expect to earn a material amount of income or incur a material loss while we operate the Saab 340B+ aircraft.  As each aircraft exits service, we will return the aircraft to Delta on an “as is, where is” basis.

 
25

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

 
Outlook (continued)
 
During the three and nine months ended September 30 2010, we incurred transaction costs of $0.9 million and $1.5 million related to the Mesaba acquisition.

Upon acquiring Mesaba, we announced that our long-term plan for our operating structure is to transition all jet flying to Pinnacle, and to merge Colgan and Mesaba’s turboprop operations with Mesaba remaining the surviving carrier.  We aspire for our regional airline subsidiaries to lead the industry with regard to safety programs and a strong safety culture, and our realignment of operations will be implemented with this goal as our highest priority.  We believe that realigning the common fleet types of Pinnacle, Mesaba and Colgan into two strong regional airlines also will provide for the most efficient, and reliable regional operations for our partners.  As we plan for the transition of our operations at Pinnacle, Mesaba and Colgan into two regional airlines, we will collaborate with the employee work groups and unions at all three airlines to determine an equitable process to combine operations.

Simultaneously with our acquisition of Mesaba, we resolved certain contractual disputes relating to our existing capacity purchase agreements with Delta.  For additional information about these disputes, refer to Note 10, Commitments and Contingencies, to our consolidated financial statements, which are included in Item 1 of this Form 10-Q.

Other Matters

We accepted delivery of two Q400 aircraft during the third quarter of 2010 and will take delivery of an additional 13 aircraft through April 2011 that will be operated under our capacity purchase agreement with Continental.  We have a commitment from Export Development Canada (“EDC”) to finance 85% of the purchase price of each aircraft, and we expect to use our internally generated funds to pay for the remaining amount.  We believe our current liquidity position and expected 2010 operating cash flow is sufficient to meet our remaining 2010 debt service requirements and the unfinanced portion of our Q400 purchase commitments.  Under our capacity purchase agreement with Continental, payments associated with our capital investment in these aircraft are fixed over the ten-year term of the contract.

Our pro-rate operations remain susceptible to both passenger demand and fuel cost.  The average revenue per available seat mile in our pro-rate markets increased by 10% in the third quarter of 2010 as compared to the third quarter of 2009.  Many analysts that follow the U.S. airline industry expect passenger revenue to continue to show year-over-year increases throughout 2010.  However, fuel prices have also increased significantly since early 2009.  Our average, fuel cost per gallon associated with our pro-rate operations increased 17% during the third quarter of 2010 as compared to the third quarter of 2009.  In April 2010, we implemented a fuel hedging program to protect against significant short-term increases in fuel prices.  We have purchased average rate options covering approximately 85% of our expected fuel requirements through December 2010.  These options have an average strike price of $2.68 per gallon, providing financial protection to us if fuel prices exceed this level in any given month.  These options are recorded as current assets on our consolidated balance sheet, and any changes in fair value are recorded through the statement of income.  We may purchase additional fuel call options in the future to help protect against fuel price increases.  We will also continue to monitor our pro-rate operations and make capacity adjustments as necessary in response to changing passenger demand and fuel prices.

  In January, we temporarily removed four aircraft within our pro-rate operations from scheduled service at New York’s LaGuardia airport.  This reduction in service was driven by an announcement that US Airways, our code-share partner at LaGuardia, intended to transfer the bulk of its regional takeoff and landing slots to Delta and significantly reduce its presence at LaGuardia.  The exchange of slots between US Airways and Delta was not approved by the Department of Transportation (the “DOT”), and we have rescheduled service with three of these aircraft at LaGuardia from June through October 2010.  In addition, we were recently awarded a contract from the DOT to operate from Boston to Plattsburgh, New York under the DOT’s Essential Air Service program, and we initiated service in June.  We are in discussions with US Airways to resume service at LaGuardia early in 2011 on a more permanent basis.

 
26

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

 
Outlook (continued)
We have been in negotiations with ALPA to amend the collective bargaining agreement covering Pinnacle’s Pilots since April 2005.  We have also been in negotiations with ALPA since late 2009 for an initial collective bargaining agreement applicable to Colgan’s Pilots.  Since the acquisition of Mesaba, we have voluntarily agreed to discuss with ALPA the terms for a potential single collective bargaining agreement that would provide for an integrated seniority list among all three of Pinnacle, Mesaba and Colgan.  If we are not successful in negotiating a combined collective bargaining agreement, then we will resume negotiations for separate agreements applying to Pinnacle and Colgan.

We are positioning ourselves to capitalize on long-term opportunities to increase the number of regional aircraft that our subsidiaries operate.  Our competitors’ capacity purchase agreements for over 400 50-seat regional jet aircraft 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 and Q400 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.

Results of Operations

The following represents our results of operations, by segment and consolidated, for the three and nine months ended September 30, 2010.  A discussion of our results of operations as compared to the same period in 2009 follows.

The Company purchased Mesaba on July 1, 2010, as discussed in Note 3, Acquisition of Mesaba, to our condensed consolidated financial statements contained in Item 1 of this Form 10-Q. Where noted, the “three and nine months ended” for Mesaba includes only the period from the purchase date through September 30, 2010.

   
Three Months Ended September 30, 2010
 
   
Pinnacle
   
Mesaba
   
Colgan
   
Consolidated
 
   
(in thousands)
 
Operating revenues
                       
Regional airlines services
  $ 161,466     $ 71,335     $ 64,396     $ 297,197  
Other
    4,666       200       272       5,138  
Total operating revenues
    166,132       71,535       64,668       302,335  
                                 
Operating expenses
                               
Salaries, wages and benefits
    45,135       31,330       15,734       92,199  
Aircraft rentals
    29,203       3,979       818       34,000  
Ground handling services
    21,766       3,015       2,747       27,528  
Aircraft maintenance, materials and repairs
    17,055       10,261       11,882       39,198  
Other rentals and landing fees
    12,723       6,421       5,075       24,219  
Aircraft fuel
    -       -       6,814       6,814  
Commissions and passenger related expense
    988       649       4,829       6,466  
Depreciation and amortization
    5,071       1,340       3,882       10,293  
Other
    17,662       11,475       6,762       35,899  
Total operating expenses
    149,603       68,470       58,543       276,616  
                                 
Operating income
    16,529       3,065       6,125       25,719  
                                 
Operating margin
    9.9 %     4.3 %     9.5 %     8.5 %
                                 
Nonoperating (expense) income
                               
Interest expense, net
                            (10,693 )
Miscellaneous income, net
                            357  
Total nonoperating expense
                            (10,336 )
Income before income taxes
                            15,383  
Income tax expense
                            (5,942 )
Net income
                          $ 9,441  

 
27

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


Results of Operations (continued)

   
Nine Months Ended September 30, 2010
 
   
Pinnacle
   
Mesaba
   
Colgan
   
Consolidated
 
   
(in thousands)
 
Operating revenues
                       
Regional airlines services
  $ 474,636     $ 71,335     $ 171,559     $ 717,530  
Other
    10,954       200       451       11,605  
Total operating revenues
    485,590       71,535       172,010       729,135  
                                 
Operating expenses
                               
Salaries, wages and benefits
    131,313       31,330       44,734       207,377  
Aircraft rentals
    87,610       3,979       2,466       94,055  
Ground handling services
    63,771       3,015       8,505       75,291  
Aircraft maintenance, materials and repairs
    49,531       10,261       33,022       92,814  
Other rentals and landing fees
    36,901       6,421       14,220       57,542  
Aircraft fuel
    -       -       19,234       19,234  
Commissions and passenger related expense
    2,744       649       12,697       16,090  
Depreciation and amortization
    15,374       1,340       11,213       27,927  
Other
    50,340       11,475       18,806       80,621  
Total operating expenses
    437,584       68,470       164,897       670,951  
                                 
Operating income
    48,006       3,065       7,113       58,184  
                                 
Operating margin
    9.9 %     4.3 %     4.1 %     8.0 %
                                 
Nonoperating (expense) income
                               
Interest expense, net
                            (29,294 )
Miscellaneous expense, net
                            (922 )
Total nonoperating expense
                            (30,216 )
Income before income taxes
                            27,968  
Income tax expense