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


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

Form 10-K
 
 
[X]
 
Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the fiscal year ended December 31, 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)

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

Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes   [   ]
      
No   [ X ]
 Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes   [   ]
      
No   [ X ]
Indicate by check mark whether registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes   [   ]
      
No   [ X ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  [   ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files).
Yes   [   ]
      
No   [   ]

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes   [   ]
      
No   [ X ]

The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the registrant was $93 million as of June 30, 2010.
As of February 22, 2011, 18,652,581 shares of common stock were outstanding.

Documents Incorporated by Reference
Certain information called for by Part III of Form 10-K is incorporated by reference to the Proxy Statement for our 2011 Annual Meeting of Stockholders to be filed with the Commission within 120 days after December 31, 2010.

 
 
 

 
 
PART I
    Forward-Looking Statements   4
       
 
Item 1.  
Business   
  4
      4
      5
      5
      6
      7
      9
      14
      15
      15
      16
      16
      17
      17
      17
       
    17
       
    23
       
 
Item 2.  
  23
      23
      23
       
 
Item 3.  
  24
      24
      25
       
   
Part II
 
       
 
Item 5.  
  25
      26
       
 
Item 6.  
  27
       
 
 
 
2

 

 


   
Part IV
 
       
  99
       
  SIGNATURES     100


 
3

 


 
Certain statements in this Annual Report on Form 10-K (the “Report” or “Form 10-K”) (or otherwise made by or on the behalf of Pinnacle Airlines Corp.) contain various forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Act of 1934, as amended (the “Exchange Act”) and the Private Securities Litigation Reform Act of 1995.  Such statements represent management's beliefs and assumptions concerning future events. When used in this document and in documents incorporated by reference, forward-looking statements include, without limitation, statements regarding financial forecasts or projections, our expectations, beliefs, intentions or future strategies that are signified by the words "expects", "anticipates", "intends", "believes" or similar language. These forward-looking statements are subject to risks, uncertainties and assumptions that could cause our actual results and the timing of certain events to differ materially from those expressed in the forward-looking statements. All forward-looking statements included in this Report are based solely on information available to us on the date of this Report.  We assume no obligation to update any forward-looking statement.

Many important factors, in addition to those discussed in this Report, could cause our results to differ materially from those expressed in the forward-looking statements. Some of the potential factors that could affect our results are described in Item 1A Risk Factors and in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations under “Overview and Outlook.”  In light of these risks and uncertainties, and others not described in this Report, the forward-looking events discussed in this Report might not occur, might occur at a different time, or might cause effects of a different magnitude or direction than presently anticipated.

Part I
Item 1. Business

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

Delta Air Lines, Inc. and its subsidiaries are referred to herein as “Delta.”  US Airways Group, Inc. and its subsidiaries are collectively referred to as “US Airways.”  On October 1, 2010, Continental Airlines, Inc. and UAL Corp., parent company of United Airlines, Inc., completed their previously announced merger, creating United Continental Holdings, Inc.  United Continental Holdings, Inc., Continental Airlines, Inc. and United Airlines, Inc. are collectively referred to herein as “United.”


Pinnacle Airlines Corp. was incorporated in 2003 as a Delaware corporation. As of December 31, 2010, we had three reportable segments consisting of Pinnacle, Mesaba, and Colgan.  Information on our segments’ operating revenues, operating income, total assets, and other financial measures can be found in Note 5, Segment Reporting, in Item 8 of this Form 10-K.

Pinnacle operates an all-regional jet fleet under two capacity purchase agreements (“CPA”) with Delta, providing regional airline capacity to Delta from Delta’s hub airports in Atlanta, Detroit, Memphis, New York City (John F. Kennedy), and Minneapolis/St. Paul.  At December 31, 2010, Pinnacle operated 126 Canadair Regional Jet (“CRJ”)-200 aircraft as a Delta Connection carrier with 650 daily departures to 113 cities in 37 states and three Canadian provinces.  Pinnacle also operated a fleet of 16 CRJ-900 aircraft as a Delta Connection carrier with 78 daily departures to 25 cities in 14 states, Belize, Mexico, and Canada.

On July 1, 2010, the Company purchased Mesaba from Delta, through the purchase of all issued and outstanding common stock of Mesaba (the “Acquisition”).  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 CPAs.  At December 31, 2010, Mesaba operated 41 CRJ-900 aircraft, providing 178 daily departures to 55 cities in 36 states.  In addition, Mesaba operated 19 CRJ-200 aircraft, providing 101 daily departures to 37 cities in 15 states.  Mesaba also operated 26 Saab 340B+ turboprop aircraft, providing 125 daily departures to 34 cities in 12 states.

 
 
4

 

Item 1. Business

Our Company (Continued)

Colgan operates an all-turboprop fleet under a regional airline CPA with United and under revenue pro-rate agreements with United and US Airways.  Colgan’s operations are focused primarily in the northeastern United States and in Texas.  As of December 31, 2010, Colgan operated 22 Bombardier Q400 aircraft as a United Express carrier, providing 115 daily departures to 21 cities in 12 states, the District of Columbia, and three Canadian provinces at United’s hub airport at Newark Liberty International Airport.  Colgan operated 24 Saab 340 aircraft as United Express from United’s hub airports in Houston and Washington-Dulles, and nine Saab 340 aircraft as US Airways Express, at Boston Logan International Airport.  Colgan offered 190 daily departures to 32 cities in eight states and the District of Columbia within its pro-rate operations.


Regional Jet Operations

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

Turboprop Operations

Our turboprop operations platform is operated by Colgan and Mesaba, providing a similar level of safe, reliable, and cost-efficient operations for our partners.  Colgan operates modern, 74-seat Q400 turboprop aircraft under a CPA with United.  The Q400 regional aircraft offers comparable operating performance to that of similarly sized regional jets on flights up to 500 miles at a lower cost.  In addition, the Q400 offers a spacious, comfortable cabin interior for passengers.  Colgan also operates under revenue pro-rate agreements with United and US Airways, utilizing the Saab 340B aircraft, a 34-seat turboprop aircraft.  Mesaba operates Saab 340B+ turboprop aircraft under a CPA with Delta.


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

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

 
 
5

 

Item 1. Business

Competition and Economic Conditions (Continued)

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

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


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

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

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

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

 
 
6

 

Item 1. Business

Industry Overview (Continued)

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

Under both CPAs and pro-rate agreements, regional airlines generally enter into code-share agreements with major airlines, pursuant to which the regional airline is authorized to use a major airline's two-letter flight designator code to identify the regional airline's flights and fares in the central reservation systems, to paint its aircraft with the colors and/or logos of its code-share partner, and to market and advertise its status as a carrier for the code-share partner. For example, Pinnacle and Mesaba primarily operate as Delta Connection carriers out of Delta’s hub locations in Atlanta, Detroit, Memphis, New York City (John F. Kennedy), Minneapolis/St. Paul, and Salt Lake City.  Colgan operates as United Express out of Newark, Houston, and Washington-Dulles, and US Airways Express with significant operations at Boston.

Under CPAs, the major airline partner generally manages and provides free of charge services such as reservations, ticketing, ground support, and gate access to the regional airline.  Under pro-rate agreements, the major airline often provides similar services to the regional airline for a price, and both partners coordinate marketing, advertising, and other promotional efforts.
 

Our operating contracts are divided into two categories: CPAs and pro-rate agreements.  The following table presents the percentage of our regional airline services revenue derived under each contract type and by code-share partner for the year ended December 31, 2010:

   
Percentage of Regional Airline Service Revenue
       
Pro-Rate Agreements
   
Source of Revenue
 
Capacity Purchase Agreements
 
Standard
 
Modified
 
Total
Delta
 
77%
 
-
 
-
 
77%
United
 
8%
 
-
 
10%
 
18%
US Airways
 
-
 
3%
 
-
 
3%
Essential Air Service
 
-
 
-
 
2%
 
2%
     Total
 
85%
 
3%
 
12%
 
100%

Capacity Purchase Agreements.  Under CPAs, our major airline partners purchase our flying capacity by paying pre-determined rates for specified flying, regardless of the number of passengers on board or the amount of revenue collected from passengers.  These arrangements typically include incentive payments that are paid if we meet certain operational performance measures.  Additionally, certain operating costs such as fuel, aviation insurance premiums, and ground handling are reimbursed or provided directly by the partner, which eliminates our risk associated with a change in the price of these goods and services. 

The Second Amended and Restated Airline Services Agreement, which pertains to the operation of Pinnacle and Mesaba’s fleet of CRJ-200 aircraft (the “CRJ-200 ASA”), is structured as a CPA.  The agreement covering the operation of Pinnacle’s CRJ-900 aircraft (the “Pinnacle CRJ-900 DCA”) for Delta is structured as a CPA. Similarly, Mesaba’s CRJ-900 aircraft agreement (the “Mesaba CRJ-900 DCA”) and Saab 340B+ aircraft agreement (the “Saab DCA”) with Delta are structured as CPAs.  Colgan’s Q400 operations for United are under a CPA (the “United Q400 CPA”).

 
 
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Item 1. Business

Our Operating Contracts (Continued)

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

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

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

 
Pinnacle and Mesaba
CRJ-200 ASA
Mesaba
CRJ-900 DCA
United
 Q400 CPA
Pinnacle
CRJ-900 DCA
Saab
340B+ DCA
Aircraft ownership   (depreciation, operating lease rentals, and/or interest expense)
Reimbursed
Excluded
Rate-Based
Reimbursed(1)
Excluded
Aviation insurance
Reimbursed
Reimbursed
Reimbursed
Reimbursed
Reimbursed
Commissions and passenger distribution costs
Excluded
Excluded
Excluded
Excluded
Excluded
Facility rentals and other station costs
Rate-Based(3)
Excluded
Excluded(2)
Excluded(2)
Reimbursed
Fuel
Excluded
Excluded
Excluded
Excluded
Excluded
Ground handling
Rate-Based(3)
Excluded
Excluded(2)
Excluded(2)
Excluded (2)
Heavy maintenance
Reimbursed
Reimbursed
Rate-Based
Reimbursed(1)
Reimbursed
Labor costs
Rate-Based
Rate-Based
Rate-Based
Rate-Based
Rate-Based
Landing fees
Reimbursed
Reimbursed
Reimbursed
Reimbursed
Reimbursed
Line maintenance
Rate-Based
Rate-Based
Rate-Based
Rate-Based
Rate-Based
Non-aircraft depreciation
Rate-Based
Rate-Based
Rate-Based
Rate-Based
Rate-Based
Other (G&A and training)
Rate-Based
Rate-Based
Rate-Based
Rate-Based
Rate-Based
Property taxes
Reimbursed
Reimbursed
Rate-Based
Reimbursed
Reimbursed

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


 
 
8

 

Item 1. Business

Our Operating Contracts (Continued)

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

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

Colgan’s pro-rate agreement with United related to its Washington-Dulles operations is also a modified pro-rate agreement that includes a fixed connecting passenger incentive payment designed to subsidize some of the markets that Colgan operates in under this agreement.  These markets would not be profitable on a stand-alone basis without the connecting passenger incentive.  The incentive amount is fixed and may only be adjusted upon the concurrence of both Colgan and United.  Colgan has the ability to exit these markets to the extent that the markets can no longer be operated profitably with the fixed connecting passenger incentive payment.

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


CRJ-200 Airline Services Agreement

Regional jet service is provided to Delta by Pinnacle and Mesaba operating 145 50-seat CRJ-200 aircraft under the CRJ-200 ASA.  Pinnacle entered into the CRJ-200 ASA in 2003, and it was amended and restated effective January 1, 2007.  It was further amended on the date of the Acquisition to include Mesaba’s CRJ-200 fleet.  At the end of its term in 2017, the CRJ-200 ASA automatically extends for additional five-year periods unless Delta provides notice to us two years prior to the termination date that Delta does not plan to extend the term.

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

 
 
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Item 1. Business

Agreements with Major Airlines (Continued)

The CRJ-200 ASA originally provided that we are required to negotiate with Delta an adjustment to our rates to the extent that we established operations with another major airline.  Under the CRJ-200 ASA, upon reaching a certain level of operations outside of our CRJ-200 ASA, and to the extent that we realized operating cost efficiencies from combining overhead in such outside operations, we were required to negotiate a rate reduction to the fixed payment that we receive under our CRJ-200 ASA related to our overhead.  The 2010 amendment to the CRJ-200 ASA eliminated this provision in exchange for fixed rate reductions through 2012.  We agreed to pay Delta $2.0 million for 2010, $2.5 million for 2011, and $2.5 million for 2012. In addition, our rate adjustment under the CRJ-200 ASA in 2013 will reflect an allocation of our overhead across all of our operations.

In connection with our acquisition of Mesaba, we negotiated a new provision to the CRJ-200 ASA with Delta that will adjust the rates we receive once we have integrated the pilots that operate the jet fleets at Mesaba and Pinnacle.  The rate adjustment will take place 12 months after the earlier of the date that a collective bargaining agreement is reached covering both Pinnacle’s and Mesaba’s pilots or the date that the jet fleets are combined such that the pilots operating the jet fleets are operating under one collective bargaining agreement.  The rate adjustment includes both a retroactive payment for the prior 12-month period that will include pilot integration costs, as well as a prospective adjustment based on our pilot related operating costs going forward.

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

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

On July 1, 2010 we reached agreement with Delta over a number of disputes primarily related to the CRJ-200 ASA that had arisen since 2007.  These issues and their resolution are discussed in greater detail in Note 3, Code-Share Agreements with Partners, in Item 8 of this Form 10-K.

Pinnacle CRJ-900 Delta Connection Agreement

Pinnacle provides regional jet service to Delta operating 76-seat CRJ-900 aircraft under the Pinnacle CRJ-900 DCA.  The Pinnacle CRJ-900 DCA provides that Pinnacle operate 16 CRJ-900 aircraft under a capacity purchase agreement.  The Pinnacle CRJ-900 DCA allows Delta the option to add an additional seven CRJ-900 aircraft to the fleet.  On July 1, 2010, we entered into an amended and restated Pinnacle CRJ-900 DCA with Delta.  Other than changes related to measuring operating performance, substantially all previous terms remain in effect.

The Pinnacle CRJ-900 DCA provides for Delta to pay pre-set rates based on the capacity we provide to Delta.  We are responsible for the costs of flight crews, maintenance, dispatch, aircraft ownership, and general and administrative costs.  In addition, Delta reimburses us for certain pass-through costs, including landing fees, most station-related costs (to the extent that we incur them), and aircraft hull and general liability insurance.  In most instances, Delta will provide fuel and ground handling services at no cost to Pinnacle, and to the extent we incur any of these costs, they are reimbursed by Delta.  We earn incentive payments (calculated as a percentage of the payments received from Delta) if we meet certain performance targets.  The Pinnacle CRJ-900 DCA also provides for reimbursements to Delta annually to the extent that our actual pre-tax margin on our Pinnacle CRJ-900 DCA operations exceeds certain thresholds.

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

 
 
10

 

Item 1. Business

Agreements with Major Airlines (Continued)

In connection with our acquisition of Mesaba, we negotiated a new provision to the Pinnacle CRJ-900 DCA with Delta that will adjust the rates we receive once we have integrated the pilots that operate the jet fleets at Mesaba and Pinnacle.  The rate adjustment will take place 12 months after the earlier of the date that a collective bargaining agreement is reached covering both Pinnacle’s and Mesaba’s pilots or the date that the jet fleets are combined such that the pilots operating the jet fleets are operating under one collective bargaining agreement.  The rate adjustment includes both a retroactive payment for the prior 12-month period that will include pilot integration costs, as well as a prospective adjustment based on our pilot-related operating costs going forward.

Mesaba CRJ-900 Delta Connection Agreement

As of December 31, 2010, Mesaba operated 41 CRJ-900 aircraft under the Mesaba CRJ-900 DCA. The Mesaba CRJ-900 DCA terminates on June 30, 2022.

Under the Mesaba CRJ-900 DCA, Delta reimburses certain direct pass-through expenses, including airport landing fees, property taxes, heavy airframe maintenance, and aircraft hull and aviation liability insurance.  In addition, Delta provides fuel, ground handling services, and various other services at no cost to Mesaba.  We are subject to certain monthly performance levels and may earn incentive payments or incur penalties if we achieve or fail to achieve certain predetermined operational performance goals.  Similar to the CRJ-200 ASA, a negotiated rate reset will occur on January 1, 2013.

The Mesaba CRJ-900 DCA also contains a provision to adjust our rates once we have integrated the pilots that operate jet fleets at Mesaba and Pinnacle that is identical to the provision contained in our CRJ-200 ASA and our Pinnacle CRJ-900 DCA.

Saab 340B+ Delta Connection Agreement

As of December 31, 2010, Mesaba operated 26 34-seat Saab 340B+ aircraft under the Saab DCA.  Prior to the Acquisition, Delta announced plans to retire Mesaba’s fleet of Saab 340B+ aircraft during 2011 and 2012. Accordingly, the Saab DCA provides for the wind-down of Mesaba’s Saab operations over a period of time not to extend beyond June 2012.  The Saab DCA was not designed to generate or use a material amount of operating cash flow.  As each aircraft exits service, we will return the aircraft to Delta on an “as is” basis.

Pursuant to the terms set forth in the Saab DCA, Mesaba is compensated at pre-set rates for the capacity that we provide to Delta.  Delta bears the risk of certain price and volume fluctuations and reimburses us certain reconciled costs on a monthly basis including landing fees, aircraft hull and passenger liability insurance, property taxes, and heavy airframe maintenance.  Delta will provide all ground handling services at no cost to Mesaba at its station locations.  In addition, Delta provides fuel to us at no cost. The Saab DCA provides for us to earn additional incentive-based compensation or incur penalties if we achieve or fail to achieve certain predetermined operational performance targets.   The Saab DCA also contains a provision to adjust rates related to pilot and mechanic costs annually for fluctuations in our actual costs during the wind-down period.

The CRJ-200 ASA, the Pinnacle CRJ-900 DCA, the Mesaba CRJ-900 DCA, and the Saab DCA all contain various termination provisions, primarily related to material breaches of the agreements.  Concurrently with the Acquisition, we agreed with Delta to a cross-default provision.  Effective July 1, 2011, the CRJ-200 ASA, the Pinnacle CRJ-900 DCA, the Mesaba CRJ-900 DCA, and the Saab DCA, as well as our note payable to Delta for the purchase of Mesaba, will all be cross-defaulted.

 
 
11

 

Item 1. Business

Agreements with Major Airlines (Continued)

United Express Capacity Purchase Agreement

Colgan operates 74-seat Q400 turboprop regional aircraft predominantly out of United’s hub at Newark Liberty International Airport.  Colgan entered into the United Q400 CPA in 2007, which terminates for each aircraft upon the tenth anniversary of the in-service date of such aircraft.  Our Q400 regional turboprop operations began on February 4, 2008, and we operated 22 Q400 aircraft under the United Q400 CPA as of December 31, 2010.  We will take delivery of an additional eight Q400 aircraft through August 2011.
 
The United Q400 CPA provides that we are compensated at pre-set rates for the capacity that we provide to United.  We are responsible for our own expenses associated with flight crews, maintenance, dispatch, aircraft ownership, and general and administrative costs.  In addition, United reimburses us without a markup for certain reconciled costs, such as landing fees, most station-related costs not otherwise provided by United or its designee; aircraft hull and passenger liability insurance (provided that our insurance rates do not exceed those typically found at other United regional airline partners); and passenger related costs.  United will also provide to Colgan at no charge fuel and ground handling services at its stations.  United may request that we provide ground handling for our flights at certain stations, in which case, we will be compensated at a predetermined rate for these ground handling services.  The United Q400 CPA also provides for the ability to earn additional incentive-based revenue or incur penalties if we achieve or fail to achieve certain operational and financial performance targets.

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

United may immediately terminate the United Q400 CPA following the occurrence of any event that constitutes cause.  To the extent that either party materially breaches the United Q400 CPA and such breach remains uncured for a period of 60 days, the non-breaching party may terminate the agreement.  United may also terminate the CPA upon our failure to maintain a certain level of safety, our failure to maintain certain specified operational performance standards, or our failure to maintain various governmental certifications and to comply with various governmental operating regulations and authorities.

United Houston Agreement

We operate 13 Saab 340B aircraft based in Houston, Texas under a code-share agreement with United (the “United Houston Agreement”).  Colgan entered into the United Houston Agreement in January 2005 for a term of five years.  Since the end of the five-year term in 2010, we continue to operate under the United Houston Agreement on a month-to-month contract and are currently in discussions with United about extending and/or modifying this agreement beyond its initial five-year term.

The United Houston Agreement is structured as a modified pro-rate agreement for which we receive all of the fares associated with local passengers and an allocated portion of the connecting passengers’ fares.  We pay all of the costs of operating the flights, including sales and distribution costs.  However, we also receive connect incentive payments from United for passengers connecting from Colgan operated flights to any flights operated by United or its other code-share partners at Houston/George Bush Intercontinental Airport.  The connect incentive payments are designed to maintain a base level of profitability in the markets that we fly out of Houston, and can result in a payment to us or from us depending on our passenger load factor in these markets.  The connect incentives are modified every six months to adjust for prospective modifications in fuel prices and certain station expenses.

 
 
12

 

Item 1. Business

Agreements with Major Airlines (Continued)

United Dulles Agreement

In October 2005, Colgan entered into a code-share agreement with United to provide services as a United Express carrier (the “United Dulles Agreement”) primarily out of Washington-Dulles.  The United Dulles Agreement was amended and restated effective November 1, 2008 and expires on November 1, 2011.  Colgan currently operates 11 Saab 340 aircraft under the United Dulles Agreement. The United Dulles Agreement is structured as a modified pro-rate agreement for which we receive all of the fares associated with local passengers and an allocated portion of the connecting passengers’ fares.  In addition, United pays us a set passenger connect incentive fee for certain of the markets that we operate under the United Dulles Agreement.  The passenger connect incentive may only be adjusted during the three-year term by mutual consent of the parties.  We have the right, however, to cease serving certain of these markets to the extent that our operations are not profitable.  We pay all of the costs of operating the flights, including sales and distribution costs.  We jointly coordinate with United all scheduling, inventory, and pricing for each local market we serve.

US Airways Express Agreement

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

In January 2011, we amended the US Airways Agreement to add Mesaba as an operating partner and to provide for the expansion of services to New York (LaGuardia) airport with seven Saab 340 B+ aircraft in March 2011.  Colgan previously operated in some of these markets but had exited all LaGuardia markets by November 2010.  All of the terms and conditions in the US Airways Agreement will apply to Mesaba’s operations at New York (LaGuardia).

 
 
13

 

Item 1. Business
 

As of December 31, 2010, we had 7,619 employees.  Flight attendants and ground operations agents included 240 and 848 part-time employees, respectively. The part-time employees work varying amounts of time, but typically work half-time or less. The follow table details the number of employees by company and by group:

Employee Group
 
Pinnacle Airlines
 Corp.
 
Pinnacle Airlines,
 Inc.
 
Mesaba Aviation,
 Inc.
 
Colgan Air,
 Inc.
 
Total
Pilots
 
-
 
1,178
 
908
 
503
 
2,589
Flight attendants
 
-
 
736
 
566
 
375
 
1,677
Ground operations personnel
 
-
 
1,034
 
-
 
211
 
1,245
Mechanics and other maintenance personnel
 
-
 
576
 
388
 
316
 
1,280
Dispatchers and crew resource personnel
 
-
 
193
 
58
 
86
 
337
Management and support personnel
 
141
 
79
 
229
 
42
 
491
Total
 
141
 
3,796
 
2,149
 
1,533
 
7,619

Labor costs are a significant component of airline expenses and can substantially affect our results. Approximately 76%, 84%, and 57% of Pinnacle, Mesaba, and Colgan employees, respectively, are represented by unions.

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

Employee Group
 
Employees Represented
 
Representing Union
 
Contract Amendable Date
Pinnacle’s pilots
 
1,178
 
Air Line Pilots Association
 
February 17, 2016
Mesaba’s pilots
 
908
 
Air Line Pilots Association
 
February 17, 2016
Colgan’s pilots
 
503
 
Air Line Pilots Association
 
February 17, 2016
Pinnacle’s flight attendants
 
736
 
United Steel Workers of America
 
February 1, 2011(1)
Mesaba’s flight attendants
 
566
 
Association of Flight Attendants
 
May 31, 2012
Colgan’s flight attendants
 
375
 
United Steel Workers of America
 
April 30, 2014 (2)
Pinnacle’s ground operations agents
 
923
 
United Steel Workers of America
 
May 23, 2015
Pinnacle’s flight dispatchers
 
59
 
Transport Workers Union of America
 
December 31, 2013
Mesaba’s flight dispatchers
 
26
 
Transport Workers Union of America
 
May 31, 2012
Mesaba’s mechanics
 
306
 
Aircraft Mechanics Fraternal Association
 
May 31, 2012
     Total unionized labor
 
5,580
       

(1)
Pinnacle and the United States Steel Workers are currently in negotiations for a new agreement covering Pinnacle’s flight attendants.
(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 will occur in April 2011.

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

 
 
14

 

Item 1. Business

Employees (Continued)

On February 17, 2011, the Company reached an agreement with the Air Line Pilots Association (“ALPA”), the union representing pilots at all three airlines.  The joint agreement represents an amendment to the collective bargaining agreements at Pinnacle and Mesaba, and a new agreement with Colgan’s pilots.  The agreement will: (1) increase compensation for our pilots to rates that approximate the industry average; (2) include a one-time signing bonus of approximately $10.1 million for Pinnacle’s pilots ($10.9 million inclusive of related payroll taxes); and (3) become amendable five years from the date the final agreement is executed.  The Company had been actively negotiating with ALPA since the collective bargaining agreement became amendable in April 2005.  During 2010, we recorded a one-time charge of $10.9 million to accrue for the signing bonus for Pinnacle’s pilots.


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

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

Pinnacle and Mesaba contract with an affiliate of the original equipment manufacturer of their CRJ-200 aircraft to perform certain routine heavy maintenance checks on their aircraft.  In addition, Mesaba performs some of the CRJ-200 routine heavy maintenance checks in-house.  Pinnacle and Mesaba also contract with a third party to perform engine overhauls on their CRJ-200 fleet.  These maintenance checks are regularly performed on a schedule approved by the manufacturer and the FAA.  In general, both the CRJ-200 and CRJ-900 aircraft do not require their first heavy maintenance checks until they have flown approximately 8,000 hours.

Mesaba completes routine heavy airframe maintenance checks on its Saab 340 B+ fleet in house.  It contracts with third parties to perform engine overhauls and propeller maintenance on its Saab fleet.

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

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


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

 
 
15

 

Item 1. Business
 
Training (Continued)

Mesaba coordinates the majority of its flight crew training in Minneapolis, Minnesota at the Pan Am International Flight Academy.  Mesaba owns and utilizes two flight simulators, one CRJ-200 and one CRJ-900 aircraft simulator, to facilitate and provide substantially all training to Mesaba flight crews.

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

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


We are committed to the safety and security of our passengers and employees.  Our most important Guiding Principle is “Never Compromise Safety.”  For example, Pinnacle led the way in the regional airline industry by being one of the first regional airlines to implement the Flight Operational Quality Assurance (“FOQA”) program.  Colgan has fully implemented the FOQA program for its fleet of Q400 aircraft and is currently preparing its Saab 340 aircraft fleet to be fully implemented and compliant with the FOQA program by the end 2011.  Colgan will be the first operator of Saab aircraft to maintain a FOQA program, and, once our Saab fleets are combined, all of our Saab operations will be incorporated into our FOQA program.  FOQA programs involve the collection and analysis of data recorded during flight to improve the safety of flight operations, air traffic control procedures, and airport and aircraft design and maintenance.

We have implemented the FAA’s Aviation Safety Action Program (“ASAP”) at all of our operating subsidiaries.  ASAP’s focus is to encourage voluntary reporting of safety issues and events that come to the attention of employees of certain certificate holders.   We also maintain Line Observation Safety Audit (“LOSA”) programs to obtain a self-evaluation of safety procedures that are invaluable in assessing opportunities for enhancing safety in flight operations.  We are also leading the way in adopting the FAA’s Safety Management System (“SMS”).  Pinnacle is already level 2 compliant under SMS and is the first regional airline to adopt SMS.  We expect our Colgan and Mesaba operations to be incorporated into our SMS programs by early 2012.


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

We were given the option under the Air Transportation Safety and Stabilization Act, signed into law on September 22, 2001, to purchase certain third-party war risk liability insurance from the U.S. government on an interim basis at rates that are more favorable than those available from the private market. As provided under this Act, we have purchased from the FAA this war risk liability insurance, which is currently set to expire on September 30, 2011.  We expect to renew the policy upon its expiration.

 
 
16

 

Item 1. Business
 

Our subsidiaries operate under air carrier certificates issued by the FAA and certificates of convenience and necessity issued by the DOT.  The DOT may alter, amend, modify or suspend these authorizations if the DOT determines that we are no longer fit to continue operations.  The FAA may suspend or revoke the air carrier certificate of one of our subsidiaries if the subsidiary fails to comply with the terms and conditions of the certificates. The DOT has established regulations affecting the operations and service of the airlines in many areas, including consumer protection, non-discrimination against disabled passengers, minimum insurance levels, and others. Failure to comply with FAA or DOT regulations can result in civil penalties, revocation of the right to operate or criminal sanctions. FAA regulations are primarily in the areas of flight operations, maintenance, ground facilities, transportation of hazardous materials, and other technical matters. The FAA requires each airline to obtain approval to operate at specific airports using specified equipment.  Under FAA regulations and with FAA approval, our subsidiaries have established a maintenance program for each type of aircraft they operate that provides for the ongoing maintenance of these aircraft, ranging from frequent routine inspections to major overhauls.  As of December 31, 2010, we had no unresolved significant violations.


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


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


Risks Related to our Financial Condition

A. Downturns in U.S. or regional economic conditions could have an adverse effect on our business and financial condition in ways that we currently cannot predict.

While the financial and credit markets have stabilized since the banking crisis that began in 2008, certain components of the capital markets remain illiquid and the availability of credit constrained.  Our prospective access to the capital markets to raise capital may be restricted, which could affect our ability to meet our obligations, our ability to react to changing economic and business conditions, and our ability to grow our operations either through expansion of our existing agreements or the addition of new agreements. Additionally, a decline in economic conditions can also impair the ability of our counterparties to satisfy their obligations to us.

 
 
17

 
 
Item 1A. Risk Factors

Risks Related to our Financial Condition (Continued)

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

Our recent growth strategy has required significant amounts of capital to acquire CRJ-900 and Q400 regional aircraft.  As a result, we have significantly increased our total debt obligations and our leverage over the past four years.  During the year ended December 31, 2010, our mandatory debt service payments totaled approximately $96 million, and we expect this amount to increase through 2011 as we acquire and finance eight additional Q400 aircraft.  See related risk factor A above for additional information related to credit availability.

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

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

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

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

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

For example, in the fall of 2011, we intend to relocate our corporate headquarters, which includes our subsidiaries’ systems operations controls centers, from our existing facilities in Memphis, Tennessee and Eagan, Minnesota to our new corporate headquarters in downtown Memphis, Tennessee.  Any disruption during the relocation process could adversely affect our operations and financial results.

 
 
18

 

Item 1A. Risk Factors

Risks Related to our Financial Condition (Continued)

D. The ability to realize fully the anticipated benefits of our acquisition of Mesaba will depend on the successful realignment of our subsidiaries.

On July 1, 2010, we acquired Mesaba, which operates a regional jet and turboprop fleet.  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.  In realigning the common fleet types of Pinnacle, Mesaba, and Colgan into two regional airlines, we may not be able to do so in a manner that allows us to achieve the anticipated cost synergies, or if achievement of such synergies takes longer or costs more than expected, the anticipated benefits of the acquisition may not be realized fully or at all or may take longer to realize than expected.  In addition, it is possible that the integration process could result in the loss of key employees, diversion of management’s attention, the disruption or interruption of or the loss of momentum in our ongoing businesses, or inconsistencies in standards, controls, procedures and policies, any of which could adversely affect our ability to maintain relationships with customers and employees or our ability to achieve the anticipated benefits of the acquisition, or could reduce our earnings or otherwise adversely affect our business and financial results.

Risks Related to our Operations

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

Many of our major airline partners have publicly indicated in the past that their committed supply of regional airline capacity is larger than they desire given current market conditions.  Specifically, they cite an oversupply of 50-seat regional jets under contractual commitments with regional airlines.  Delta in particular has reduced both the number of 50-seat regional jets within its network and the number of regional airlines with which it contracts.  There are currently more than 300 50-seat aircraft within the Delta Connection system.  In addition to reducing the number of 50-seat jets under contract, major airlines have reduced the utilization of regional aircraft, thereby reducing the revenue paid to regional airlines under capacity purchase agreements.  Delta’s utilization of our 50-seat CRJ-200 aircraft decreased by 2% in 2010.  This decrease had a negative impact on our regional airline services revenue and profitability.

Mesa filed for Chapter 11 Bankruptcy reorganization on January 5, 2010.  This was caused in large part by a significant number of regional aircraft that it owns or leases but that are no longer committed to fly under an agreement with a major airline partner.  As major airlines seek to reduce the number of 50-seat aircraft within their networks, other regional airlines may also be forced to restructure their operations.  In an environment where the supply of regional aircraft exceeds the demand from our major airline partners, our competitors may price their regional airline products below cost or otherwise compete aggressively to retain business.  In addition, regional airlines with more financial resources may make loans or pay financial incentives to retain or increase business with major airlines.  For example, in 2009, SkyWest extended to United a secured term loan in the amount of $80 million and a credit facility with a cap in the amount of $49 million in exchange for an extension on the term of some of its regional airline services agreements with United.  Regional airlines with more financial resources may also acquire or merge with other regional airlines in an attempt to mitigate any reductions of regional airline services with their major airline partners.

We have fewer financial resources than many of our competitors, and therefore we may be at a competitive disadvantage as we compete for new business opportunities.  Additionally, while our CPAs with Delta contractually terminate on varying dates from December 31, 2017 through June 30, 2022, Delta may still seek to reduce our level of operations, either through reduced utilization of our fleet or through attempted reductions in the number of aircraft that we operate.   Oversupply of regional aircraft may also lead to reductions of service under our operating agreements with our other partners.  These reductions in service may lead to reduced profitability and we may be forced to sell, sublease, or otherwise reduce the number of aircraft that we own or lease.

 
 
19

 

Item 1A. Risk Factors

Risks Related to our Operations (Continued)

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

We are highly dependent on Delta, our largest customer.  Our code-share agreements with Delta generated approximately 77% of our consolidated regional airline services revenue during 2010, and approximately 80% of our operating fleet is utilized by Delta.  In addition, our entire fleet of 145 CRJ-200 aircraft and 41 of our CRJ-900 aircraft are subleased from Delta under leases that terminate if our airline services agreements with Delta terminate.  We would be significantly and negatively affected should one of our code-share agreements with Delta be terminated, and we likely would be unable to find an immediate source of revenue or earnings to offset such a loss.  We may be unable to enter into substitute code-share arrangements, and any such arrangements we might secure may not be as favorable to us as our current agreements.  Operating as an independent airline would be a departure from our business strategy and would require considerable time and resources.

            Our code-share agreements with Delta and our other partners include various minimum operating performance requirements, which if we fail to meet, provide the partner with the ability to terminate the agreement with little or no notice requirement.  Additionally, in connection with the acquisition of Mesaba, all of the Company’s capacity purchase agreements with Delta now contain cross-default provisions, which will be effective on July 1, 2011.  Therefore, any failure on our part to meet minimum operating performance requirements under one contract will provide Delta the legal right to terminate any or all of our code-share agreements with Delta. 

Certain conditions that are beyond our control, such as weather, may negatively affect our performance such that we may fall below the minimum operating requirements.  For example, in June 2008, Delta gave notice to Pinnacle that it intended to terminate the Pinnacle CRJ-900 DCA, citing failure to meet on-time performance requirements in the CRJ-900 DCA.  We disputed Delta’s right to terminate the Pinnacle CRJ-900 DCA, and we subsequently agreed with Delta to continue operating under the Pinnacle CRJ-900 DCA.  Although we were successful in this instance in keeping our Pinnacle CRJ-900 DCA intact with Delta, a future attempt by Delta or an attempt by another of our partners to terminate one of our code-share agreements resulting from our failure to meet our minimum operating performance requirements would, if successful, have a material negative impact on our financial performance and liquidity. 

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

We are highly dependent upon Delta and United, our capacity purchase agreement partners, for the services they provide to support our current operations.  For example, we currently use or rely upon Delta's, United’s, and, to a lesser degree, US Airways’ systems, facilities, and services to support a significant portion of our operations, including airport and terminal facilities and operations, information technology support, ticketing and reservations, scheduling, dispatching, fuel purchasing, and ground handling services.  Were we to lose any of our operations with these partners, particularly related to our Pinnacle CRJ-900 DCA and United Q400 CPA agreements with Delta and United, respectively, for which we bear the ownership risks associated with the aircraft, we would need to replace all of the services mentioned above and make the other arrangements necessary to fly as an independent airline or otherwise find a suitable use for the aircraft.

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

Under our capacity purchase code-share agreements with Delta and United, the major airline bears the risk related to the cost of certain reimbursable expenses that they are contractually required to repay in full to us.  With respect to other costs, our code-share partner is obligated to pay to us amounts at predetermined rates based on the level of capacity that we generate for them.  If our controllable costs exceed our rate-based revenue, our financial results will be adversely affected.  For example, certain CRJ-200 maintenance expenses are intended to be covered by our rate-based revenue.  As our CRJ-200 fleet ages, the maintenance costs required to support the fleet are increasing, which places additional pressure on our profitability.  During the year ended December 31, 2010, approximately 39% of our total costs were pass-through costs and approximately 61% of our costs were controllable costs related to our rate-based revenue.

 
 
20

 

Item 1A. Risk Factors

Risks Related to our Operations (Continued)
 
I. Our ability to operate profitably under our pro-rate code-share agreements is heavily dependent on the price of aircraft fuel. Volatility in the price of fuel presents a market uncertainty and could have a significant negative impact on our operating results.
 
Under our pro-rate code-share agreements, we bear the risk associated with fares, passenger demand, and competition within each market.  Similarly, we also incur all of the costs associated with operating these flights, including those costs typically reimbursed or paid directly by the major airline under a capacity purchase agreement. For example, Colgan’s pro-rate agreements expose Colgan to fuel price volatility.  In recent years, fuel prices have been extremely volatile over short periods of time.  Our ability to offset increases in the price of fuel by raising fares or surcharges may be limited, primarily because of reduced demand for air travel and competitiveness of the airline industry.  To the extent that we incur expenses that exceed the revenue we receive from passenger fares and incentive-based revenue, our financial results will be negatively affected.

J. We are at risk of adverse publicity stemming from any accident involving our aircraft.

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

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

 
Airlines are subject to extensive regulatory and legal requirements that involve significant compliance costs.  In the last several years, Congress has passed laws, and the DOT, the FAA, and the Transportation Security Administration (“TSA”) have issued regulations relating to the operation of airlines that have required significant expenditures.  We expect to continue to incur substantial expenses in complying with government regulations.

For example, prompted by the February 2009 Colgan Flight 3407 accident near Buffalo, New York, passengers and governmental authorities have raised industry-wide questions about pilot qualifications, training and fatigue. On August 1, 2010, the United States Congress passed into law the Airline Safety and Federal Aviation Administration Act of 2010.  The law adds new certification requirements for entry-level commercial pilots, requires additional emergency training, improves availability of pilot records through a centralized database, and mandates stricter rules to minimize pilot fatigue.

The Airline Safety and Federal Aviation Administration Act of 2010 also:

• 
requires that all airline pilots obtain an Airline Transport Pilot license, which is currently only needed by captains,
• 
mandates that the FAA within 90 days set up a new database of pilot records so that airlines will have access to more information before they hire someone for the cockpit, and
• 
directs the FAA within one year to rewrite the rules for how long pilots can work.

We cannot predict whether the cost of continued compliance for all present and future laws, rules, regulations, and certification requirements will have a material adverse effect on our operations.

 
 
21

 

Item 1A. Risk Factors

Risks Related to our Operations (Continued)

L. We are subject to many forms of environmental regulation and may incur substantial costs as a result.

We are also subject to increasingly stringent federal, state, and local laws, regulations and ordinances relating to the protection of the environment, including those relating to emissions in the air. Compliance with all environmental laws and regulations can require significant expenditures.  There is increasing regulatory focus in North America on climate change and greenhouse gas emissions.  While we cannot yet determine what the final regulatory programs will be in the United States or in other areas in which we do business, such climate change-related regulatory activity in the future may adversely affect our business and financial results.

Risks Related to our Labor Costs and Collective Bargaining Agreements

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

Labor costs are not directly reimbursed by any of our code-share partners.  Rather, compensation for these costs is intended to be covered by the payments based on pre-set rates for block hours, departures, and fixed costs.  Labor costs constitute a significant portion, ranging from 31% to 33%, of our total operating costs.  Pressure to increase these costs beyond standard industry wages, and therefore beyond the limits intended to be covered by the fixed payments we receive from our code-share partners, is increased by the high degree of unionization of our workforce.  As of December 31, 2010, 73% of our employees were unionized.

Additionally, on February 17, 2011, we entered into a new agreement with ALPA, the union representing pilots at Pinnacle, Mesaba, and Colgan.  The joint agreement represents an amendment to the collective bargaining agreements at Pinnacle and Mesaba, and a first agreement with Colgan’s pilots.  The terms of the agreement will materially increase our pilots’ salaries, wages, and benefits costs.  The agreement contains increased pay rates for pilots at Pinnacle and Colgan, as well as a material signing bonus for Pinnacle’s pilots.  An increase in our labor costs over standard industry wages could result in a material reduction to our earnings, and could affect our future prospects for additional business opportunities.

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

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

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

We compete against the other major and regional U.S. airlines for pilots, mechanics, and other employee groups essential for providing airlines services.  Several of the other airlines offer wage and benefit packages that exceed ours.  We may be required to increase wages and/or benefits in order to attract and retain qualified employees or risk considerable turnover, which could negatively affect our ability to provide a quality product to our customers and therefore negatively affect our relationship with our customers. 

Similarly, as we further expand our Q400 operations for United, our need increases for qualified pilots, mechanics, and other airline-specific employees.  If we are unable to hire, train, and retain qualified pilots we would be unable to efficiently run our operations and our competitive ability would be impaired.  Our business could be harmed and revenue reduced if, due to a shortage of pilots, we are forced to cancel flights and forego earning incentive-based revenue under our code-share agreements.

 
 
22

 


All staff comments received from the SEC were resolved as of the date of this filing.



As shown in the following table, the Company’s aircraft fleet consisted of 202 regional jet aircraft and 81 turboprop aircraft at December 31, 2010.

Aircraft Type
 
Number of Aircraft Leased
 
Number of Aircraft Owned
 
Total Aircraft
 
Standard Seating Configuration
CRJ-200
 
145
 
-
 
145
 
50
CRJ-900
 
41
 
16
 
57
 
76
   Total regional jets
 
186
 
16
 
202
   
Q400
 
-
 
22
 
22
 
74
Saab 340B+
 
26
 
-
 
26
 
34
Saab 340
 
10(1)
 
23
 
33
 
34
   Total turboprops
 
36
 
45
 
81
   
   Total aircraft
 
222
 
61
 
283
   

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


The Company had the following significant dedicated facilities as of December 31, 2010:

Location
 
Description
 
Lease Expiration Date
Memphis, TN
 
Pinnacle Airlines, Inc. Headquarters and Corporate Education Center
 
August 2011
Memphis, TN
 
Pinnacle Airlines Corp. and Colgan Air, Inc. Headquarters
 
August 2011
Minneapolis, MN
 
Mesaba Aviation, Inc. Headquarters
 
November 2016
Memphis, TN
 
Hangar and Maintenance Facility
 
December 2016
Knoxville, TN
 
Hangar and Maintenance Facility
 
Termination of the CRJ-200 ASA
Des Moines, IA
 
Hangar and Maintenance Facility
 
December 2018
Wausau, WI
 
Hangar and Maintenance Facility
 
December 2011(2)
Minneapolis, MN
 
Hangar and Maintenance Facility
 
April 2009 (1)
Detroit, MI
 
Hangar and Maintenance Facility
 
November 2015
Dulles, VA
 
Hangar and Maintenance Facility
 
April 2011
Albany, NY
 
Hangar and Maintenance Facility
 
December 2010 (1)
Houston, TX
 
Hangar and Maintenance Facility
 
June 2011

(1) 
Lease continuing on a month-to-month basis.
(2) 
Upon expiration, we have the option to extend the lease.


 
 
23

 

Item 2.  Properties

Facilities (Continued)

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

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

In December 2010, we entered into a 13-year lease whereby we will occupy 170,000 square feet of the One Commerce Square building in downtown Memphis.  We intend to vacate our existing headquarters facilities in Memphis in the fall of 2011 and begin occupying this space.  Ultimately, we expect to relocate Mesaba’s headquarters to this space as well.


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

September 11, 2001 Litigation.  Colgan is a defendant in litigation resulting from the September 11, 2001 terrorist attacks.  We believe we will prevail in this litigation; moreover, we believe that any adverse outcome from this litigation would be covered by insurance and would therefore have no material adverse effect on our financial position, results of operations, and cash flows.

Colgan Flight 3407.  On February 12, 2009, Colgan Flight 3407, operated under the Company’s United Q400 CPA, crashed in a neighborhood near the Buffalo Niagara International Airport in Buffalo, New York. All 49 people aboard, including 45 passengers and four members of the flight crew, died in the accident. Additionally, one individual died inside the home destroyed by the aircraft’s impact.  Several lawsuits related to this accident have been filed against the Company, and additional litigation is anticipated.  We carry aviation liability insurance and believe that this insurance is sufficient to cover any liability arising from this accident.


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

 
 
24

 

Item 3.  Legal Proceedings


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

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

2010
 
High
   
Low
 
First quarter
  $ 8.58     $ 7.03  
Second quarter
  $ 7.80     $ 5.11  
Third quarter
  $ 6.15     $ 4.54  
Fourth quarter
  $ 8.21     $ 5.33  

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

As of February 21, 2011, there were approximately 32 holders of record of our common stock.  We have paid no cash dividends on our common stock and have no current intention of doing so in the future.

The information under the caption “Securities Authorized for Issuance under Equity Compensation Plans,” appearing in the Proxy Statement for our 2011 Annual Meeting of Stockholders, to be filed with the Commission within the 120 days after December 31, 2010, is hereby incorporated by reference.

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

 
 
25

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

Performance Graph

The following graph compares total shareholder return on the Company’s common stock over the five-year period ending December 31, 2010, with the cumulative total returns (assuming reinvestment of dividends) on the American Stock Exchange Airline Industry Index and the NASDAQ Composite Index. The stock performance graph assumes that the value of the investment in our common stock and each index (including reinvestment of dividends) was $100 on December 31, 2005. The graph below represents historical stock performance and is not necessarily indicative of future stock price performance.
 


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

   
Years Ended December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
Statement of Operations Data:
 
(in thousands, except per share data)
 
                               
Total operating revenues(1)
  $ 1,020,767     $ 845,508     $ 864,785     $ 787,374     $ 824,623  
Total operating expenses (2)
    959,234       764,799       819,178       734,963       697,075  
Operating income(1)(2)
    61,533       80,709       45,607       52,411       127,548  
Operating income as a percentage of operating revenues(1)(2)
    6.0 %     9.5 %     5.3 %     6.7 %     15.5 %
Nonoperating expense(3)
    (40,650 )     (38,471 )     (54,196 )     (8,462 )     (10,706 )
Income tax expense(4)
    (8,113 )     (382 )     (2,408 )     (13,526 )     (43,758 )
Net income (loss)
    12,770       41,856       (10,997 )     30,423       73,084  
Basic earnings (loss) per share
  $ 0.70     $ 2.33     $ (0.62 )   $ 1.46     $ 3.33  
Diluted earnings (loss) per share
  $ 0.69     $ 2.31     $ (0.62 )   $ 1.32     $ 3.33  
Shares used in computing basic earnings (loss) per share
    18,132       17,969       17,865       20,897       21,945  
Shares used in computing diluted earnings (loss) per share
    18,558       18,133       17,865       23,116       21,974  
                                         

(1) 
Operating revenues and operating income for the year ended December 31, 2010 were affected by the July 1, 2010 acquisition of Mesaba.  For more information, refer to Note 4, Acquisition of Mesaba, in Item 8 of this Form 10-K. Operating revenues and operating income for the year ended December 31, 2007 were affected by the January 18, 2007 acquisition of Colgan, partially offset by changes in CRJ-200 ASA with Delta.
(2) 
Operating expenses for the year ended December 31, 2010 were affected by the July 1, 2010 acquisition of Mesaba.  For more information, refer to Note 4, Acquisition of Mesaba, in Item 8 of this Form 10-K.   Operating expenses for the year ended December 31, 2008 were affected by a $13.5 million impairment charge on Colgan’s goodwill and aircraft retirement costs. For more information, refer to Note 15, Impairment and Aircraft Retirement Costs, in Item 8 of this Form 10-K. Operating expenses for the year ended December 31, 2007 were affected by the January 18, 2007 acquisition of Colgan.  Operating expenses for the year ended December 31, 2006 were affected by a benefit of $43.6 million related to the bankruptcies of Northwest and Mesaba.
(3) 
Nonoperating expense for the year ended December 31, 2008 includes a $16.8 million impairment charge on our ARS investments.  For more information, refer to Note 7, Investments and Fair Value Measurements, in Item 8 of this Form 10-K.
(4) 
Income tax expense for the year ended December 31, 2009 includes a benefit of $13.6 million related to the settlement of the Internal Revenue Service’s examination of the Company’s federal income tax returns for calendar years 2003, 2004, and 2005.  For more information, refer to Note 14, Income Taxes, in Item 8 of this Form 10-K.


 
 
27

 
 
Item 6.  Selected Financial Data
   
As of December 31,
 
Balance Sheet Data:
 
2010
   
2009
   
2008
   
2007
   
2006
 
   
(in thousands)
 
                               
Cash and cash equivalents (1)(3)
  $ 100,084     $ 91,574     $ 69,469     $ 26,785     $ 705  
Investments
    1,852       2,723       116,900       186,850       72,700  
Property and equipment, net (1)
    935,138       731,073       719,931       257,168       40,985  
Total assets (1)(2)
    1,498,798       1,289,420       1,127,702       699,548       299,185  
Long-term debt obligations, including leasing arrangements (1)
    667,875       521,961       603,026       174,208       90,208  
Stockholders' equity (1)
    119,493       102,237       55,734       71,054       114,468  

(1) 
The balance sheet was affected by the July 1, 2010 acquisition of Mesaba and the January 18, 2007 acquisition of Colgan.
(2) 
For the year ended December 31, 2010 and 2009, total assets include approximately $275 million and $300 million, respectively on long-term receivables related to potential claims related to Colgan Flight 3407. This amount is offset in its entirety by a corresponding liability.  For more information, see Note 16, Commitments and Contingencies, in Item 8 of this Form 10-K.
(3) 
For the year ended December 31, 2006, cash and cash equivalents did not include the recurring CRJ-200 ASA end-of-month payment of $31.9 million, which was received on January 2, 2007 as December 31, 2006 was not a business day.

   
Years Ended December 31,
 
   
2010(1)
   
2009
   
2008
   
2007(1)
   
2006
 
                               
Other Data:
                             
Revenue passengers (in thousands)
    16,391       13,473       12,926       11,494       8,988  
Revenue passenger miles (“RPMs”) (in thousands) (2)
    6,942,182       5,281,461       5,420,673       4,898,188       4,288,551  
Available seat miles (“ASMs”) (in thousands) (3)
    9,438,766       7,204,094       7,380,490       6,604,082       5,640,629  
Passenger load factor (4)
    73.5 %     73.3 %     73.4 %     74.2 %     76.0 %
Operating revenue per ASM (in cents)
    10.81       11.74       11.72       11.92       14.62  
Operating revenue per block hour
  $ 1,481     $ 1,498     $ 1,451     $ 1,392     $ 1,987  
Operating cost per ASM (in cents)
    10.16       10.62       11.10       11.13       12.36  
Operating cost per block hour
  $ 1,391     $ 1,355     $ 1,375     $ 1,300     $ 1,679  
Block hours
                                       
       Regional jets
    523,148       426,432       442,911       438,988       415,069  
       Turboprops
    166,291       138,166       152,890       126,675       -  
Departures
                                       
       Regional jets
    326,751       273,077       267,893       265,418       251,091  
       Turboprops
    134,137       110,568       121,635       107,171       -  
Average daily utilization (in block hours)
                                       
       Regional jets
    8.32       8.26       8.75       8.73       9.17  
       Turboprops
    7.11       7.84       7.86       7.32       -  
Average stage length (in miles)
    402       374       396       321       470  
Number of operating aircraft (end of period)
                                       
       Regional jets
    202       142       142       138       124  
       Turboprops
    81       48       51       47       -  
Employees
    7,619       5,106       5,644       5,316       3,860  
   

(1) 
We acquired Mesaba on July 1, 2010.  Data for 2010 includes Mesaba data and statistics from the date of acquisition through the end of the year.  We acquired Colgan on January 18, 2007.  Data for 2007 includes Colgan data and statistics from the date of acquisition through the end of the year.
(2) 
Revenue passenger miles represent the number of miles flown by revenue passengers.
(3) 
Available seat miles represent the number of seats available for passengers multiplied by the number of miles the seats are flown.
(4) 
Passenger load factor equals revenue passenger miles divided by available seat miles.
 
 
28

 
 
Item 6.  Selected Financial Data
 
Certain Statistical Information:
 
The following tables present our operating expenses per block hour and operating expenses per available seat mile.  While not relevant to our consolidated financial results, this data is used as an analytic in the airline industry.  See Results of Operations in Item 7 of this Form 10-K for more information on our operating expenses.
 
   
Years Ended December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
Operating expenses per block hour:
                             
    Salaries, wages and benefits
  $ 449     $ 399     $ 369     $ 346     $ 329  
    Aircraft rentals
    186       214       216       245       636  
    Ground handling services
    148       165       162       170       207  
    Aircraft maintenance, materials and repairs
    195       174       157       159       83  
    Other rentals and landing fees
    118       125       120       104       104  
    Aircraft fuel
    38       39       83       68       263  
    Commissions and passenger related expenses
    31       37       45       46       12  
    Depreciation and amortization
    57       63       44       16       10  
    Other
    169       135       156       146       140  
    Provision for decreases in losses associated with bankruptcy filings
         of Northwest and Mesaba
    -       -       -       -       (105 )
    Impairment and aircraft retirement costs
    -       4       23       -       -  
             Total operating expenses
  $ 1,391     $ 1,355     $ 1,375     $ 1,300     $ 1,679  

   
Years Ended December 31,
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
Operating expenses per available seat mile (in cents):
                             
    Salaries, wages and benefits
    3.28       3.12       2.98       2.97       2.43  
    Aircraft rentals
    1.36       1.68       1.74       2.10       4.68  
    Ground handling services
    1.08       1.29       1.31       1.46       1.53  
Aircraft maintenance, materials and repairs
    1.42       1.36       1.26       1.36       0.61  
    Other rentals and landing fees
    0.86       0.98       0.97       0.89       0.76  
    Aircraft fuel
    0.28       0.31       0.67       0.58       1.93  
    Commissions and passenger related expenses
    0.23       0.29       0.37       0.39       0.09  
    Depreciation and amortization
    0.41       0.49       0.36       0.14       0.07  
    Other
    1.24       1.07       1.26       1.24       1.03  
    Provision for decreases in losses associated with bankruptcy filings
         of Northwest and Mesaba
    -       -       -       -       (0.77 )
    Impairment and aircraft retirement costs
    -       0.03       0.18       -       -  
             Total operating expenses
    10.16       10.62       11.10       11.13       12.36  




2010 Results

Our consolidated operating income decreased by $19.2 million in 2010 as compared to 2009.  Pinnacle experienced a decline in operating income of $10.6 million, primarily attributable to a one-time charge of $10.9 million related to a signing bonus contained in an agreement with ALPA, as more fully discussed below.  Colgan’s operating income decreased by $15.4 million.  The large decline was primarily related to substantially higher maintenance costs on our Saab and Q400 fleets, higher pilot and flight attendant wages due to an increase in employees prior to the launch of new Q400 service in late 2010, and higher fuel costs in our pro-rate operations.  These significant cost increases were partially offset by a 9% increase in revenue per available seat mile within our pro-rate operations.  Mesaba earned $6.8 million in operating income during the six months ended December 31, 2010.

Mesaba Acquisition

On July 1, 2010, we purchased Mesaba from Delta for total consideration of $75 million.  Mesaba operates a fleet of 41 CRJ-900 aircraft, 19 CRJ-200 aircraft, and 26 Saab 340B+ aircraft as a Delta Connection carrier, with hubs in Atlanta, Detroit, Memphis, Minneapolis/St. Paul, and Salt Lake City.  All of Mesaba’s aircraft are leased from Delta under contracts conterminous with their respective operating agreements with Delta.  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 26 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.  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.

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 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.

Simultaneously with our acquisition of Mesaba, we resolved certain contractual disputes relating to our existing capacity purchase agreements with Delta resulting in no gains or losses recognized and greater stability in our future cash flows under these contracts.  For additional information about these disputes, refer to Note 3, Code-Share Agreements with Partners, and Note 4, Acquisition of Mesaba, to our consolidated financial statements, which are included in Item 8 of this Form 10-K.

 
 
30

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

Overview and Outlook (Continued)

ALPA Collective Bargaining Agreement

We had been in negotiations with ALPA to amend the collective bargaining agreement covering Pinnacle’s Pilots since April 2005, and we had been negotiating with ALPA to establish an initial collective bargaining agreement applicable to Colgan’s Pilots since late 2009.  Upon the acquisition of Mesaba, we agreed with ALPA to negotiate for a new combined collective bargaining agreement covering the pilots at all three of our subsidiaries, and in December 2010 we reached a tentative agreement.  The tentative agreement contains substantial salary and benefits increases for our pilots, bringing their total compensation in line with the average for airlines with similarly sized aircraft.  The tentative agreement also contains a one-time $10.9 million signing bonus that will be paid to pilots at Pinnacle Airlines.  We accrued this one-time bonus in the fourth quarter of 2010.  Pilots at all three airlines ratified the contract in February 2011, and the provisions will go into effect immediately.  Exclusive of the one-time signing bonus, we expect our total pilot costs to increase by approximately $18 million during 2011 as a result of the new agreement.

In connection with our acquisition of Mesaba, we modified our existing capacity purchase agreements with Delta to provide for a rate adjustment that will be effective upon the earlier of the date that we implement a combined collective bargaining agreement covering both Pinnacle’s and Mesaba’s pilots, or the date that the jet operations of Pinnacle and Mesaba are combined under a single operating certificate the (“Adjustment Trigger Date”).  This rate adjustment is designed to increase Pinnacle’s rates commensurate with the increase in pilot labor costs related to Pinnacle’s Delta operations.  The rate adjustment will be calculated and agreed to by us and Delta 12 months after the Adjustment Trigger Date.  At that time, we will receive a one-time retroactive adjustment related to the prior 12 months for the increase in our pilot costs, inclusive of training and displacement related to the merging of Pinnacle’s and Mesaba’s pilot groups.  In addition, we will receive a prospective adjustment payable for future periods such that our rates pertaining to pilot costs will be approximately equivalent to our actual pilot costs at the time of the rate adjustment.  We believe that the Adjustment Trigger Date will occur upon the implementation of our new agreement with ALPA in March 2011.  While we will not receive any cash payments related to these adjustments from Delta until 2012, we currently estimate that the one-time retroactive adjustment related to the 12 months ended March 2012 could be as much as $20 million, and the prospective rate increase that would begin in March 2012 could be as much as $14 million annually.  These rate adjustments will be based on assumptions about cost allocations between the pilot groups of our operating subsidiaries, and will be subject to negotiation with Delta.  No assurances can be made that the amount of the rate adjustments ultimately agreed to with Delta will equal our current estimates.  While we are still evaluating the timing of revenue recognition associated with these adjustments, we currently believe that we will not recognize this revenue until 2012 upon the final determination of the amount.    In addition, with the exception of annual increases indexed to the Producer Price Index, the rates associated with our pilot labor costs under all of our CPAs with Delta will not be adjusted again until 2018.

Operational Integration Plan

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.

Since the acquisition, we have completed the plan to integrate the jet operations of Pinnacle and Mesaba, and to merge Colgan’s and Mesaba’s turboprop operations.  Implementation of our integration plan is subject to FAA approval, which we expect to obtain during the first half of 2011.  We currently anticipate that completion of our integration will take 12 to 18 months after approval by the FAA.  Our implementation plan will include significant one-time costs associated with training, relocation and displacement for our pilots, flight attendants and mechanics, information technology costs related to the integration of systems and operating processes, and relocation, retention and severance packages for management employees as we combine administrative functions.  We currently estimate that these one-time integration costs will be approximately $12 to $14 million, the majority of which we expect to incur during 2011.  An insignificant amount of integration costs were incurred in 2010.

 
 
31

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

Overview and Outlook (Continued)

Other Items

We generated $109.4 million in cash from operations during 2010, and we ended the year with $100.1 million in cash and cash equivalents.  Our operating cash flow included an influx of approximately $42 million related to our 2009 federal income tax refund that we received in 2010.  We did not make any federal income tax payments in 2010 and do not anticipate making federal income tax payments in 2011 due to the accelerated depreciation recognized for tax purposes related to our newly acquired CRJ-900 and Q400 aircraft. Operating cash flow was also improved in 2010 due to the acquisition of Mesaba, which contributed approximately $23 million in operating cash flow.  Mesaba’s operating cash flow included a one-time benefit of approximately $14 million related to the establishment of our new CPAs with Delta.  Our operating cash flow in 2011 will decline for several reasons, including the fact that we will not receive an income tax refund and because Mesaba’s operating cash flow will exclude the one-time benefit described above.

We accepted delivery of eight Q400 aircraft in late 2010 and we will take delivery of an additional eight aircraft through August 2011 that will be operated under our capacity purchase agreement with United.  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 2011 operating cash flow is sufficient to meet our remaining 2011 debt service requirements and the unfinanced portion of our Q400 purchase commitments.  Under our capacity purchase agreement with United, payments associated with our capital investment in these aircraft are fixed over the ten-year term of the contract.  We expect that our Q400 growth will have a positive impact on operating income in 2011.

In March 2011, we will begin operating seven leased Saab 340B+ aircraft within our pro-rate operations with scheduled service at New York’s LaGuardia airport as a US Airways Express carrier.  This increase in service was driven by the delay in the transfer of the bulk of US Airways’ regional takeoff and landing slots at LaGuardia to Delta (the “LaGuardia Slot Swap”).  While we expect these operations to continue to at least the end of 2011, our agreement with US Airways is designed to be temporary and we will end service at LaGuardia upon any resolution of the LaGuardia Slot Swap between US Airways, Delta and the Department of Transportation.

We continue to position ourselves to capitalize on long-term profitable 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.

 
 
32

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


The following represents our results of operations, by segment and consolidated, for the year ended December 31, 2010.  A discussion of our results of operations as compared to 2009 and 2008 follows.

The Company purchased Mesaba on July 1, 2010, as discussed in Note 4, Acquisition of Mesaba, to our consolidated notes to the financial statements contained in Item 8 of this Form 10-K.  Mesaba’s financial information includes only the period from the acquisition date through December 31, 2010.

   
Year Ended December 31, 2010
 
   
Pinnacle
   
Mesaba
   
Colgan
   
Consolidated
 
   
(in thousands)
 
Operating revenues
                       
Regional airlines services
  $ 632,508     $ 141,178     $ 230,810     $ 1,004,496  
Other
    15,533       204       534       16,271  
Total operating revenues
    648,041       141,382       231,344       1,020,767  
                                 
Operating expenses
                               
Salaries, wages and benefits
    186,294       62,016       61,481       309,791  
Aircraft rentals
    116,814       7,959       3,214       127,987  
Ground handling services
    84,794       5,981       11,128       101,903  
Aircraft maintenance, materials
     and repairs
    67,783       20,020       46,502       134,305  
Other rentals and landing fees
    49,433       12,292       19,486       81,211  
Aircraft fuel
    -       -       26,011       26,011  
Commissions and passenger
     related expenses
    3,649       1,319       16,862       21,830  
Depreciation and amortization
    20,544       2,676       15,927       39,147  
Other
    69,251       22,272       25,526       117,049  
Total operating expenses
    598,562       134,535       226,137       959,234  
                                 
Operating income
    49,479       6,847       5,207       61,533  
                                 
Operating margin
    7.6 %     4.8 %     2.3 %     6.0 %
                                 
Nonoperating (expense) income
                               
Interest expense, net
                            (40,745 )
Investment gain, net
                            1,776  
Miscellaneous expense
                            (1,681 )
Total nonoperating expense
                            (40,650 )
Income before income taxes
                            20,883  
Income tax expense
                            (8,113 )
Net income
                          $ 12,770  


 
 
33

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

Results of Operations (Continued)

Consolidated and Segmented Results of Operations

Consolidated

   
Years Ended December 31,
 
   
2010
   
% Change
2010 - 2009
   
2009
   
% Change
 2009 - 2008
   
2008
 
                               
Total operating revenue
  $ 1,020,767       21 %   $ 845,508       (2 )%   $ 864,785  
Total operating expenses
    959,234       25 %     764,799       (7 )%     819,178  
Operating income
    61,533       (24 )%     80,709       77 %     45,607  
Operating margin
    6.0 %             9.5 %             5.3 %
                                         
Total nonoperating expense
    (40,650 )     6 %     (38,471 )     (29 )%     (54,196 )
                                         
Income (loss) before income taxes
    20,883       (51 )%     42,238       (592 )%     (8,589 )
Income tax expense
    (8,113 )     2,024 %     (382 )     (84 )%     (2,408 )
Net income (loss)
  $ 12,770       (69 )%   $ 41,856       (481 )%   $ (10,997 )

2010 Compared to 2009

The following summarizes certain nonrecurring items affecting our results for the years ended December 31, 2010, 2009, and 2008 (in thousands):

   
Years Ended December 31,
 
   
2010
   
2009
   
2008
 
   
Pre-tax
   
After Tax
   
Pre-tax
   
After Tax
   
Pre-tax
   
After Tax
 
Pilot signing bonus
  $ 10,873     $ 6,839     $ -     $ -     $ -     $ -  
Impairment and aircraft retirement charges
    -       -       1,980       1,219       13,548       8,688  
Excess of property insurance proceeds
   over cost basis of aircraft
    -       -       (835 )     (514 )     -       -  
Total effect on operating income
    10,873       6,839       1,145       705       13,548       8,688  
Net investment (gain) loss
    -       -       (3,877 )     (3,713 )     16,800       16,091  
Ineffective portion of hedge
    -       -       1,424       877       -       -  
Reversal of interest on tax reserves
    -       -       (2,926 )     (1,843 )     -       -  
Gain on debt extinguishment
    -       -       (1,856 )     (1,118 )     -       -  
IRS settlement
    -       -       -       (13,551 )     -       -  
Total effect on nonoperating expense
    -       -       (7,235 )     (19,348 )     16,800       16,091  
Total nonrecurring charges (gains)
  $ 10,873     $ 6,839     $ (6,090 )   $ (18,643 )   $ 30,348     $ 24,779  

On December 17, 2010, the Company reached a tentative agreement with ALPA for a collective bargaining agreement covering pilots at Pinnacle, Mesaba, and Colgan.  The agreement provided for a signing bonus of $10.1 million ($10.9 million inclusive of related payroll taxes) for Pinnacle’s pilots.  This signing bonus, along with related employment taxes, was recorded as a charge to Pinnacle’s salaries, wages, and benefits expense in December 2010.  On February 17, 2011, the pilots at Pinnacle, Mesaba, and Colgan ratified the contract.

 
 
34

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

Results of Operations (Continued)

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

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

During 2008, we recorded charges of $13.5 million ($8.7 million net of tax) related to the impairment of Colgan’s goodwill and certain charges necessary to retire several of Colgan’s aircraft associated with its pro-rate operations.  In addition, during 2008, we recorded an impairment charge of $16.8 million ($16.1 million net of tax) to write down the value of our portfolio of auction rate securities to fair value.

Operating Revenues

Operating revenue of $1.0 billion for the year ended December 31, 2010 increased $175.3 million, or 21%, compared to 2009.  The increase in operating revenue was largely attributable to the acquisition of Mesaba, which contributed additional revenue of $141.4 million. The increase was also related to changes in our capacity purchase related operating revenue, primarily caused by changes in our operating fleet size, aircraft utilization, and changes in the costs that are directly reimbursed by our partners.  In addition, changes in our pro-rate related operating revenue are primarily caused by changes in the scope of our pro-rate operations, and by the average load factor, average passenger fare, and average incentive payments we receive from our partners and under our Essential Air Service (“EAS”) agreements.  (These changes are discussed in greater detail within our segmented results of operations.)

Operating Expenses

Operating expenses increased by $194.4 million, or 25%, as compared to 2009.  This is primarily attributable to the acquisition of Mesaba, which contributed additional operating expenses of $134.5 million. (This change and others are discussed in greater detail within our segmented results of operations.)
 
Nonoperating Expense

Net nonoperating expense of $40.7 million for the year ended December 31, 2010 increased by approximately $2.2 million as compared to 2009.  This increase is related to $3.9 million in interest expense on the Promissory Note, a decrease in interest income of $1.9 million due to the sale of our ARS portfolio in 2009, and a $1.7 million increase in nonoperating expense related to decreases in the fair value of our interest rate “Swaptions,” which are further discussed in Note 9, Hedging Activities, in Item 8 of this Form 10-K.  In addition, we recorded net valuation gains of $1.8 million on our ARS call options for the year ended December 31, 2010 as compared to a $3.9 million net investment gain related to the sale of our ARS portfolio recorded in 2009.  During the three months ended March 31, 2009, the Company recorded a gain of $1.9 million on the extinguishment of $12 million par amount of the Notes, partially offset by a $1.4 million charge for the previously unrecognized hedge related costs for the debt related to the aircraft destroyed in Flight 3407.  Interest expense increased by $2.9 million related to the reversal of interest on income tax reserves during the three months ended March 31, 2009.  Partially offsetting these increases was a $9.6 million decrease in interest expense related to the repurchase of our senior convertible notes in February 2010. 

 
 
35

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

Results of Operations (Continued)

Income Tax Expense

For the years ended December 31, 2010 and 2009, we recorded income tax expense of $8.1 million and $0.4 million, respectively.  During 2009, we reached a settlement with the IRS regarding our examination for tax years 2003 through 2005. The Service had proposed a number of adjustments to our returns totaling approximately $35.0 million of additional tax, plus accrued interest and penalties on these proposed adjustments.  The Company agreed to pay approximately $3.0 million of additional income tax and accrued interest in settlement of all open tax matters for the years examined.  As a result, we recorded a reduction to income tax expense of $13.6 million in 2009 to reduce our accrued income tax reserves pursuant to the settlement.  See Note 14, Income Taxes, in Item 8 of this Form 10-K for more discussion.  

2009 Compared to 2008

Operating Revenues

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

Operating Expenses

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

Nonoperating Expense

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

Income Tax Expense

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

 
 
36

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

Results of Operations (Continued)

Pinnacle Operating Statistics

   
Years Ended December 31,
 
   
2010
   
% Change
2010 - 2009
   
2009
   
% Change
2009 - 2008
   
2008
 
                               
Revenue passengers (in thousands)
    10,537       (2 )%     10,771       4 %     10,393  
Revenue passenger miles (“RPMs”) (in thousands)
    4,490,065       (3 )%     4,640,392       (4 )%     4,844,526  
Available seat miles (“ASMs”) (in thousands)
    6,009,188       (2 )%     6,108,609       (3 )%     6,320,269  
Passenger load factor
    74.7 %  
(1.3) pts.
      76.0 %  
(0.7) pts.
      76.7 %
Operating revenue per ASM (in cents)
    10.78       7 %     10.12       4 %     9.70  
Operating cost per ASM (in cents)
    9.96       9 %     9.13       3 %     8.85  
Operating revenue per block hour
  $ 1,520       5 %   $ 1,449       5 %   $ 1,384  
Operating cost per block hour
  $ 1,404       7 %   $ 1,308       4 %   $ 1,263  
Block hours
    426,285       (0 )%     426,432       (4 )%     442,911  
Departures
    274,850       1 %     273,077       2 %     267,893  
Average daily utilization (block hours)
    8.22       (0 )%     8.26       (6 )%     8.75  
Average stage length (miles)
    419       (2 )%     426       (7 )%     460  
Number of operating aircraft (end of period)
                                       
    CRJ-200
    126       0 %     126       2 %     124  
    CRJ-900
    16       0 %     16       (11 )%     18 (1)
Employees (end of period)
    3,796       3 %     3,675       (13 )%     4,204  

(1) 
On October 1, 2008, we entered into an agreement with Delta to operate on a short-term basis seven additional CRJ-900 aircraft (the “Temporary Aircraft”).  The Temporary Aircraft were returned in early 2009.


 
 
37

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

Results of Operations (Continued)

Pinnacle Financial Results

   
Years Ended December 31,
 
   
2010
   
% Change
2010 – 2009
   
2009
   
% Change
2009 – 2008
   
2008
 
Operating revenues
                             
    Regional airline services
                             
        CRJ-200
  $ 557,118       3 %   $ 540,939       (5 )%   $ 569,020  
        CRJ-900
    75,390       11 %     68,159       94 %     35,146  
    Other
    15,533       76 %     8,839       (1 )%     8,923  
Total operating revenues
    648,041       5 %     617,937       1 %     613,089  

Operating expenses
                             
Salaries, wages and benefits
    186,294       11 %     168,049       2 %     164,775  
Aircraft rentals
    116,814       0 %     116,768       (3 )%     120,932  
Ground handling services
    84,794       4 %     81,161       (3 )%     83,336  
Aircraft maintenance, materials and repairs
    67,783       14 %     59,630       21 %     49,238  
Other rentals and landing fees
    49,433       (2 )%     50,293       (5 )%     52,994  
Commissions and passenger related expense
    3,649       (4 )%     3,818       (38 )%     6,160  
Depreciation and amortization
    20,544       1 %     20,247       52 %     13,346  
Other
    69,251       20 %     57,878       (16 )%     68,691  
Total operating expenses
    598,562       7 %     557,844       (0 )%     559,472  
                                         
Operating income
  $ 49,479       (18 )%   $ 60,093       12 %   $ 53,617  
                                         
Operating margin
    7.6 %  
(2.1) pts.
      9.7 %  
1.0 pts.
      8.7 %

Pinnacle Operating Revenues

2010 Compared to 2009

Regional Airline Services

CRJ-200.  For the year ended December 31, 2010, revenue earned under our CRJ-200 ASA of $557.1 million increased by $16.2 million, or 3%. 

For the year ended December 31, 2010, the rates that Delta pays us under our CRJ-200 ASA increased by 4%.  Changes in our rates are tied to changes in the Producer Price Index, which increased by 4% from December 2008 to December 2009.  This increase in rates caused an increase in our revenue of approximately $8.5 million.

Additionally, a change in reimbursable expenses caused revenue to increase by $9.7 million for the year ended December 31, 2010.  For the year ended December 31, 2010, revenue from reimbursable expenses increased by $5.9 million related to heavy maintenance checks, $3.0 million for increased property taxes, $2.2 million related to increased insurance expenses, and $2.9 million in other reimbursable expenses.  These increases were offset by a decrease of $4.3 million primarily related to reduced deicing expense, which is discussed further below.

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

Results of Operations (Continued)

As a result of our amended CRJ-200 ASA, effective July 1, 2010, certain expenses changed classification to become pass–through expenses, while certain rates in the CRJ-200 ASA were reduced.  These changes, along with a change in methodology related to departure based revenue, caused revenue for 2010 to decrease by approximately $2 million, as compared to 2009. 
 
Pinnacle CRJ-900.  For the year ended December 31, 2010, revenue earned under the Pinnacle CRJ-900 DCA of $75.4 million increased by $7.2 million, or 11%, as compared to 2009.  This increase is primarily related to an increase in the 2010 rates that Delta pays us under our Pinnacle CRJ-900 DCA, which resulted in an increase of revenue of approximately $4.6 million.  In addition, revenue increased due to an increase in aircraft utilization, which caused block hours to increase by 2% and revenue to increase by approximately $0.2 million.  The remaining increase is attributable to an increase in reimbursable expenses, which increased revenue by approximately $3.5 million.  Offsetting this increase is a $1.1 million decrease in incentive revenue earned during the year ended December 31, 2010, primarily as a result of changes in our Pinnacle CRJ-900 DCA that became effective July 1, 2010.

Other Revenue

Other revenue increased $6.7 million, or 76%, for the year ended December 31, 2010 as compared to 2009.  This increase is related to an increase in third party ground handling revenue, as we are providing these services to other airlines in an increased number of cities.

2009 Compared to 2008

Regional Airline Services

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

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

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

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

Results of Operations (Continued)

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

Other Revenue

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

Pinnacle Operating Expenses

2010 Com