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Pinnacle Airlines 10-K 2012
form10-k.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, 2011
 
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.)
One Commerce Square
40 S. Main Street
Memphis, Tennessee
(Address of principal executive offices)
 
 
38103
(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
 
Securities registered pursuant to section 12 (g) of the Act: None

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files).
Yes   [ X ]
      
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 [ X ]
Non-accelerated filer [   ]
 
Smaller reporting company [   ]

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

The aggregate market value of the voting and non-voting common equity stock held by non-affiliates of the registrant was $79 million as of June 30, 2011.

As of May 1, 2012, 18,961,788 shares of common stock were outstanding.


 
 

 
 
TABLE OF CONTENTS

PART I

 
  Forward-Looking Statements  4
     
  4
    4
    7
    7
    7
    9
    9
    10
    13
    13
    13
    13
    14
    14
    14
    14
     
  14
     
  20
     
  21
    21
    21
     
  22
    22
    22
     
  22
     
 
Part II
 
     
  23
    24
     
  25
     
 
 
2

 
 




 
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.  In light of these risks and uncertainties, and others not described in this Report, the forward-looking events discussed in this Report might not occur, might occur at a different time, or might cause effects of a different magnitude or direction than presently anticipated.

Part I

Pinnacle Airlines Corp., an airline holding company incorporated in 2003 as a Delaware corporation, and its four wholly-owned operating subsidiaries, Pinnacle Airlines, Inc. (“Pinnacle”), Mesaba Aviation, Inc. (“Mesaba”), Colgan Air, Inc. (“Colgan”) and Pinnacle East Coast Operations Inc. (“PECO”), are collectively referred to in this report as the “Company,” “we,” “our,” and “us” except as otherwise noted.

The Company’s corporate headquarters office is located in Memphis, Tennessee. As of December 31, 2011, the Company employed approximately 7,800 people in North America.


On April 1, 2012 (the “Petition Date”), Pinnacle Airlines Corp. and its subsidiaries (collectively, the “Debtors”) filed voluntary petitions for relief (the “Bankruptcy Filing”) under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”), case number 12-11343-REG.  The Debtors will continue to operate their businesses as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court.

The Bankruptcy Filing is intended to permit the Company to reorganize and improve liquidity, reduce costs, wind down unprofitable contracts and focus on the most valuable business lines to enable sustainable profitability.  The Company’s goal is to develop and implement a reorganization plan that meets the standards for confirmation under the Bankruptcy Code.  Confirmation of a reorganization plan could materially alter the classifications and amounts reported in the Company’s consolidated financial statements, which do not give effect to any adjustments to the carrying values of assets or amounts of liabilities that might be necessary as a consequence of confirmation of a reorganization plan or other arrangement, or the effect of any operational changes that may be implemented.

Operation and Implication of the Bankruptcy Filing

Under Section 362 of the Bankruptcy Code, the filing of voluntary bankruptcy petitions by the Debtors automatically stayed most actions against the Debtors, including most actions to collect indebtedness incurred prior to the Petition Date or to exercise control over the Debtors’ property.  Accordingly, although the Bankruptcy Filing triggered defaults for certain of the Debtors’ debt and lease obligations, counterparties are stayed from taking any actions as a result of such defaults.  Absent an order of the Bankruptcy Court, substantially all of the Company’s pre-petition liabilities are subject to settlement under a reorganization plan.  As a result of the Bankruptcy Filing, the realization of assets and the satisfaction of liabilities are subject to uncertainty.  The Debtors, operating as debtors-in-possession under the Bankruptcy Code, may, subject to approval of the Bankruptcy Court, sell or otherwise dispose of assets and liquidate or settle liabilities for amounts other than those reflected in the consolidated financial statements.  Further, a confirmed reorganization plan or other arrangement may materially change the amounts and classifications in the Company’s consolidated financial statements.

 
4

 

 
Subsequent to the Petition Date, the Debtors received approval from the Bankruptcy Court to pay or otherwise honor pre-petition obligations generally designed to stabilize the Company’s operations.  These obligations relate to certain employee wages, salaries and benefits, and payments to fuel counterparties and other service providers in the ordinary course for goods and services received after the Petition Date.  The Debtors have retained, pursuant to Bankruptcy Court approval, legal and financial professionals to advise the Debtors in connection with the Bankruptcy Filing and certain other professionals to provide services and advice in the ordinary course of business.  From time to time, the Debtors may seek Bankruptcy Court approval to retain additional professionals.

The U.S. Trustee for the Southern District of New York has appointed an official committee of unsecured creditors (the “UCC”).  The UCC and its legal representatives have a right to be heard before the Bankruptcy Court on matters affecting the Debtors.  There can be no assurance that the UCC will support the Debtors’ positions on matters to be presented to the Bankruptcy Court in the future or on any reorganization plan.

Reorganization Plan

In order for the Company to emerge successfully from Chapter 11, the Company must obtain the Bankruptcy Court’s approval of a reorganization plan, which will enable the Company to transition from Chapter 11 into ordinary course operations outside of bankruptcy.  In connection with a reorganization plan, the Company also may require a new credit facility, or “exit financing.”  The Company’s ability to obtain such approval and financing will depend on, among other things, the timing and outcome of various ongoing matters related to the Bankruptcy Filing.  A reorganization plan determines the rights and satisfaction of claims of various creditors and parties-in-interest, and is subject to the ultimate outcome of negotiations and Bankruptcy Court decisions ongoing through the date on which the reorganization plan is confirmed.

The Company presently expects that any proposed reorganization plan will provide, among other things, mechanisms for settlement of claims against the Debtors’ estates, treatment of the Company’s existing equity and debt holders, and certain corporate governance and administrative matters pertaining to the reorganized Company.  Any proposed reorganization plan will be subject to revision prior to submission to the Bankruptcy Court based upon discussions with the Company’s creditors and other interested parties, and thereafter in response to interested parties’ objections and the requirements of the Bankruptcy Code and Bankruptcy Court.  There can be no assurance that the Company will be able to secure approval for the Company’s proposed reorganization plan from the Bankruptcy Court or that the Company’s proposed reorganization plan will be accepted by the lender under the DIP Financing, as discussed below.  In the event that the Company does not secure approval of the proposed reorganization plan, the Company’s outstanding principal and interest obligations could become immediately due and payable.

Agreements with United Airlines and Export Development Canada

Since 2007, Colgan has performed regional air services for Continental Airlines, Inc. (“Continental”) with respect to Q400 aircraft predominantly out of Continental’s hub at Newark Liberty International Airport pursuant to a capacity purchase agreement (the “Q400 CPA”) and related ancillary agreements related to fuel and ground handling, each dated as of February 2, 2007 (together with the Q400 CPA, collectively, the “Prior Agreements”).  Pinnacle Airlines Corp. guaranteed Colgan’s obligations under the Prior Agreements pursuant to the Guarantee Agreement, dated as of February 2, 2007 (the “Continental Guarantee”).

The Q400 CPA provided for Colgan to be compensated at pre-set rates for the capacity that it provided to Continental.  Colgan was responsible for its own expenses associated with flight crews, maintenance, dispatch, aircraft ownership, and general and administrative costs.  In addition, Continental reimbursed Colgan without markup for certain reconciled costs, such as landing fees, most station-related costs not otherwise provided by Continental or its designee, aircraft hull and passenger liability insurance (subject to certain requirements) and passenger-related costs.

On April 23, 2012, the Bankruptcy Court granted the Debtors final approval pursuant to court order [ECF No. 173] (the “Final Order”) to reject the Prior Agreements and to terminate the Continental Guarantee, as more fully described below.  The Final Order also authorized the Debtors to enter into the New Agreements (as defined below).

 
5

 


United Agreement.  The Final Order authorized the Debtors to perform their obligations under a term sheet (the “United Agreement”) among Pinnacle Airlines Corp., Colgan, Continental Airlines, Inc., United Air Lines, Inc. (together with Continental Airlines, Inc., “United”) and Export Development Canada (“EDC”).  The material terms of the United Agreement include:

·  
The term of the United Agreement commenced April 3, 2012 and will end on November 30, 2012, unless otherwise agreed by the Debtors and United.
·  
During the term of the United Agreement, United shall pay increased rates for Colgan’s provision of regional air services related to Colgan’s Q400 and Saab aircraft on terms otherwise substantially similar to those contained in the Prior Agreements, which have been rejected by the Debtors in connection with their Chapter 11 proceedings, as more fully described below.
·  
The regional air services provided to United will be wound down gradually over the term of the United Agreement, with the first three Q400 aircraft and the first five Saab aircraft being wound down in May 2012.  It is anticipated that the regional air services provided by the Saab aircraft and the Q400 aircraft will be fully wound down by July 31, 2012 and November 30, 2012, respectively.
·  
United will pay EDC directly for Colgan’s continued use of each Q400 aircraft and related aircraft equipment financed by EDC (the “Q400 Covered Equipment”) until such aircraft are wound down in accordance with the United Agreement, pursuant to terms separately agreed by United and EDC.  Colgan will remain responsible for insuring the Q400 Covered Equipment during its period of continued use.
·  
Pinnacle Airlines Corp. guarantees Colgan’s obligations under the United Agreement.

EDC Agreement.  The Final Order also authorized the Debtors to perform their obligations under a term sheet (the “EDC Agreement,” and together with the United Agreement, the “New Agreements”) among Pinnacle Airlines Corp., EDC and United.  The material terms of the EDC Agreement include:

·  
As of the Petition Date, Colgan shall be deemed to have returned to EDC all Q400 Covered Equipment used to perform the regional air services under the United Agreement.
·  
EDC waived its right to seek administrative expense claims against the Debtors in connection with such return but reserved its right to seek administrative expense claims against the Debtors in connection with any breach of the EDC Agreement itself.
·  
Colgan shall be entitled to use such Q400 Covered Equipment in connection with its provision of regional air services under the United Agreement.
·  
Upon the wind-down of any such Q400 Covered Equipment under the United Agreement, Colgan is required to physically return such Q400 Covered Equipment to EDC.  Upon such return, EDC is authorized to dispose of such Q400 Covered Equipment without the consent of the Debtors.

Debtor-in-Possession Financing

In connection with the Company’s Chapter 11 cases, on May 18, 2012, the Company and Delta Air Lines, Inc. (“Delta”) entered into a debtor-in-possession credit agreement pursuant to which Delta agreed to provide $74,285,000 in secured debtor-in-possession financing (“DIP Financing”) to Pinnacle Airlines Corp., guaranteed by Pinnacle Airlines Corp.’s subsidiaries.  Such DIP Financing was approved by final order of the Bankruptcy Court on May 17, 2012 [ECF No. 316].

The DIP Financing has a term of one year from the date of the filing of the Company’s Chapter 11 cases (subject to early termination in certain instances) and accrues interest at the rate of 12.5% per annum.  There is no additional fee payable to Delta in connection with the DIP Financing.  The DIP Financing contains customary default provisions, and certain milestones that must be met relating to the delivery of a six-year business plan, filing and confirmation of a plan of reorganization and modifications to collective bargaining agreements through a settlement or relief under Section 1113 of the Bankruptcy Code.  Approximately $46.2 million of the DIP Financing was used to repay Delta’s existing secured promissory note and the balance of the DIP Financing is additional available working capital for the Company.  If certain conditions are satisfied, including substantial consummation of a plan of reorganization that is reasonably acceptable to Delta and the absence of a continuing or unwaived default or event of default, Delta has agreed to convert the DIP Financing into a senior secured exit financing facility.

 
6

 



As of December 31, 2011, our reportable segments consisted of Pinnacle, Mesaba, and Colgan.  Financial information on our segments’ operating revenues, operating income, total assets, and other financial measures can be found in Note 6, Segment Reporting, in Item 8 of this Form 10-K.

 The Company’s key customers as of December 31, 2011 were Delta and United.  We also operated flights on behalf of US Airways Group, Inc. (“US Airways”) during 2011.  Prior to the Bankruptcy Filing, our operating contracts fell under two categories: capacity purchase agreements (“CPA”) and revenue pro-rate agreements (“Pro-Rate”).   The following table presents the percentage of our regional airline services revenue derived by contract type and by code-share partner for the year ended December 31, 2011:

   
Percentage of Regional Airline Service Revenue
 
Code-Share Partner
 
CPA
   
Pro-Rate
   
Total
 
Delta
    74 %     -       74 %
United
    12 %     10 %     22 %
US Airways
    -       4 %     4 %
     Total
    86 %     14 %     100 %


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.In the United States, the airline industry has traditionally been dominated by several major airlines, including Delta, US Airways, United, and American Airlines, Inc. (“American”). The major airlines offer scheduled flights to most major U.S. cities, numerous smaller U.S. cities, and cities throughout the world through hub and spoke networks.
 
Low cost carriers, such as Southwest Airlines Co. (“Southwest”), JetBlue Airways Corporation, Frontier Airlines, Inc., and Spirit Airlines, Inc. generally offer fewer conveniences 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 flights to and from major population bases.
 
Regional airlines typically operate smaller aircraft on lower-volume routes than major airlines and low cost carriers.  In contrast to low cost carriers, regional airlines generally do not establish an independent route system to compete with the major airlines. Rather, regional airlines typically enter into relationships with one or more major airlines, pursuant to which the regional airline agrees to use its smaller, lower-cost aircraft to carry passengers booked and ticketed by the major airline between a hub of the major airline and a smaller outlying city. In exchange for such services, the major airline pays the regional airline either a fixed flight fee, termed "contract" or “fixed-fee” flights, or receives a percentage of applicable ticket revenues, termed “pro-rate” or “revenue-sharing” flights.
 
The airline industry is highly competitive. The Company’s subsidiaries compete principally with other code-sharing regional airlines.  Our primary competitors among regional airlines with CPAs include Comair, Inc. (a wholly-owned subsidiary of Delta); Air Wisconsin Airlines Corporation; American Eagle Holding Corporation (a wholly-owned subsidiary of AMR Corporation); SkyWest, Inc. (“SkyWest”), which also owns and operates ExpressJet Airlines, Inc.; Horizon Air Industries, Inc.  (a wholly-owned subsidiary of Alaska Air Group Inc.); Mesa Air Group, Inc.; Republic Airways Holdings Inc. which owns and operates Chautauqua Airlines, Inc., Shuttle America Corporation, Republic Airline Inc., Frontier Airlines, Inc.; and Trans States Airlines, Inc., Go Jet Airlines, LLC, and Compass Airlines, Inc. (all of which are wholly-owned subsidiaries of Trans States Holdings, Inc.).  The principal competitive factors for regional airlines with CPAs include the overall cost of the agreement, customer service, aircraft types, and operating performance.


Following significant operating losses in 2008, we were able to improve our operating performance in 2009. In 2010, we increased our revenue, bolstered by the acquisition of Mesaba from Delta/Northwest, although overall profitability decreased.  We had anticipated improvements and continued growth in 2011. However, as discussed below, 2011 and first quarter 2012 presented severe challenges, ultimately culminating in the Bankruptcy Filing.  The Company underwent significant changes in senior management in 2011, including the resignations of the CEO and CFO in March 2011 and June 2011, respectively. In July 2011, the Company hired a new CEO and a new CFO.  The new CEO spearheaded a thorough assessment of our business to identify areas of vulnerability and opportunities for improvement. This assessment revealed five critical factors that had combined to jeopardize the Company’s viability: (1) delays in integrating the operating certificates of our subsidiaries; (2) developments arising out of a new, joint collective bargaining agreement with our pilots; (3) increasingly unprofitable contracts with airline customers; (4) poor operational performance; and (5) increased operational expenses. These factors are discussed individually below.

 
7

 


Delayed Integration and Synergies. Upon the acquisition of Mesaba in mid-2010, we had intended to consolidate our jet and turboprop flying into two operating certificates as quickly as possible, instead of retaining a separate operating certificate for each of the three airline subsidiaries. Maintaining an additional operating certificate imposes various redundant costs and inefficiencies.

The consolidation process, however, proved substantially more difficult and time-consuming than anticipated. The Mesaba jet operation was originally scheduled to be moved under the Pinnacle operating certificate in May 2011, but delays in obtaining FAA approval delayed this move until January 2012. As a result, the anticipated cost savings were deferred, and we had to expend substantial additional resources, including hiring additional employees and consultants, to accomplish the consolidation. Additionally, the management structure in place prior to a January 2012 reorganization to streamline the structure was not conducive to realizing the efficiencies of consolidation.

Although the Mesaba jets have been moved under the Pinnacle operating certificate as of the date of this filing, full integration of maintenance and flight operations of Pinnacle and Mesaba jets is not expected to be completed until early 2013. We estimate that we have incurred unanticipated costs and lost revenue in the tens of millions of dollars as a result of delayed integration and synergies.

ALPA Collective Bargaining Agreement.  In February 2011, the Company signed a collective bargaining agreement with the Air Line Pilots Association, International (“ALPA”), the joint representative of our pilots across all of our subsidiaries. This new agreement (the “ALPA JCBA”) united approximately 3,000 pilots under a single agreement and provided significantly enhanced pay, benefits and work rules.  Compensation of our pilots is currently above market average with respect to wages, benefits, and work rules. In addition to the ALPA JCBA’s compensation provisions, the integration of the three pilot groups resulted in unforeseen and substantial complexities and expense stemming from the creation of an “integrated seniority list” (“ISL”). Before the integration, the pilots of each of our three airline subsidiaries were represented by separate ALPA merger committees and each of our three airline subsidiaries maintained its own, separate list ranking the subsidiary’s pilots by seniority. The ALPA merger committees utilized an arbitration process to resolve the differences among the three committees regarding the methodology by which the three pilot lists would be integrated.   The arbitration decision (the “Bloch Ruling”) implementing the ISL merged the three lists, creating a single, integrated list across all subsidiaries,  resulting in new relative seniority relationships among thousands of pilots.

The implementation of the ISL following the Bloch Ruling has had severe, disruptive and expensive consequences on the filling of pilot vacancies and associated training costs. Pilots are permitted to “bid” on vacancies (e.g., to obtain a new domicile, new aircraft, new category), and those bids are honored according to seniority. Each time a pilot moves to fill a vacancy, his or her prior position becomes vacant and must be filled in the same manner. Pilots must undergo training every time they move to a new aircraft or category, and they are entitled under the ALPA JCBA to receive their full salary during training, during which time they are not flying. Before the integration, pilots could bid only on vacancies within their own particular airline.  After the integration, pilots were allowed to bid across all three airlines, precipitating an overwhelming number of transfer requests across a substantially more disparate set of routes and fleet types. The ALPA JCBA contains minimal effective safeguards against the increased training costs imposed by such transfers, and the Bloch Ruling did not establish a sufficient number of “protected” pilot positions to provide meaningful “fences” preventing pilots from freely transferring among the airlines.

The volume of training has been further impacted by the delayed operating certificate integration issues discussed above.  Pilots must be trained not only for transfers to different aircraft, but also transfers to the same aircraft type if it flies under a different operating certificate.  Thus, the delays in operating certificate consolidation described above have further increased the amount of required training.  Training has also increased as a result of flying reductions. As discussed below, we have been working to eliminate unprofitable routes and aircraft types. While essential to our viability, these reductions have further substantially increased the number of pilot re-assignments and associated training costs because pilot terminations are based on “juniority,” meaning that relatively senior pilots displaced by flying reductions must be reassigned to other routes and aircraft flown by more junior pilots. Each reassignment requires costly retraining (often of multiple pilots), with accompanying grounding of the pilot(s) at full salary for non-productive time. This issue was particularly acute in the case of our recent elimination of Mesaba Saab flying for Delta, given the significantly greater relative seniority of Mesaba pilots, and their ability to transfer freely into other subsidiaries after creation of the ISL.

 
8

 


The lack of meaningful ISL fences, integration delays and flying downsizing have resulted in substantial additional training costs and decreased productivity.

Unprofitable Contracts.  A detailed review undertaken in the latter half of 2011 also revealed that the non-compensable costs incurred by the Company under our customer agreements, including certain of the substantially increased labor costs resulting from the ALPA JCBA, as well as maintenance and other expenses related to an aging fleet, were exceeding, or would soon begin to exceed, the fees received under these contracts. In the aggregate, we were incurring losses on our partner contracts.

 More specifically, we determined that none of the Saab Pro-Rate flying was profitable. Nor was the Q400 CPA with United viable at the rates being paid. Two of three CPAs with Delta covering CRJ-200s and CRJ-900s were deemed potentially viable, but not without the benefit of contractual rate increases scheduled to be introduced over the course of 2012-2013, which would require extensive negotiations with Delta. In the interim, these contracts were being impacted by the new pilot wage rates and unforeseen expenses associated with the vacancy bidding process under the ALPA JCBA, along with incremental costs associated with an aging fleet.

           Operational Performance and Expenses.  Beginning in the fall of 2010, Pinnacle’s operating performance began to decline, due primarily to a pilot staffing shortage. Colgan’s operating performance also suffered due to new Q400 hub operations in Washington, D.C., Cleveland, and Houston, which imposed significant maintenance and crew expenses that were not recoverable under Colgan’s Q400 CPA agreement with United. For the first six months of 2011, we incurred contract penalties totaling approximately $3.4 million associated with poor performance by Pinnacle and Colgan.


Under CPAs, the major airline partner purchases the regional airline’s 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 to the regional airline that are paid if certain operational performance measures are met and operational penalties that are owed if the regional airline fails to 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 the regional airline’s risk associated with a change in the price of these goods and services.  Costs incurred under a CPA are classified into one of the following categories:

·  
Reimbursed – Those costs that are reimbursed, plus any applicable margin.
·  
Rate-based – Payments are based on each block hour, flight hour, and departure provided and the number of aircraft in the fleet.  These payments are designed to cover those CPA-related expenses that are not covered by reimbursement payments, including overhead costs.  The regional airline assumes the risk that underlying costs for these activities differ from 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 the regional airline’s financial statements.


Under Pro-Rate agreements, the regional airline manages its own inventory of unsold capacity and sets fare levels in the local markets that it serves.  The regional airline retains all of the revenue for passenger flying within its local markets and not connecting to partners’ flights.  For connecting passengers, the passenger fare is pro-rated between the regional airline and the 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, the regional airline bears the risk associated with fares, passenger demand, and competition within the markets served.  The regional airline incurs all of the costs associated with operating these flights, including those costs, like fuel, that are typically reimbursed or paid directly by the major airline under a CPA.  In some instances, the regional airline has the ability to earn incentive-based revenue should specified performance metrics be achieved.

 
9

 



Capacity Purchase Agreements

As of December 31, 2011, we provided regional jet and turboprop service under four CPAs that represent a significant portion of our operations.  Our three CPAs with Delta consist of:

·  
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”);
·  
the agreement covering the operation of Pinnacle’s CRJ-900 aircraft (the “Pinnacle CRJ-900 DCA”); and
·  
the agreement covering Mesaba’s CRJ-900 aircraft (the “Mesaba CRJ-900 DCA”).

The details concerning each of the CPAs with Delta are discussed in greater detail below.  An additional CPA, covering our Q400 turboprop operations for United (the “Q400 CPA”), is scheduled to end in November 2012.

In November 2011, we ended our Delta Saab turboprop operations, which we operated on Delta’s behalf and were structured under a CPA.  Prior to our acquisition of Mesaba on July 1, 2010 (the “Acquisition”), Delta announced plans to retire Mesaba’s fleet of Saab 340B+ aircraft. The Saab 340B+ aircraft agreement with Delta (the “Saab DCA”) was not designed to generate or use a material amount of operating cash flow.

The CRJ-200 ASA, the Pinnacle CRJ-900 DCA, and the Mesaba CRJ-900 DCA all contain various termination provisions, primarily related to material breaches of the agreements.  Concurrent 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 resulting from the Acquisition, are all subject to cross-default provisions.

CRJ-200 Airline Services Agreement.  As of December 31, 2011, Pinnacle and Mesaba provided regional jet service to Delta by operating 141 50-seat CRJ-200 aircraft under the CRJ-200 ASA.

On April 1, 2012, Pinnacle Airlines Corp., Pinnacle Airlines, Inc. and Delta entered into a Third Amended and Restated Airline Services Agreement (the “A&R CRJ-200 ASA”), which amends and restates the CRJ-200 ASA.  The A&R CRJ-200 ASA modifies rates paid by Delta for services performed by Pinnacle Airlines, Inc., including changes to the margin payment.  In addition, the term of the CRJ-200 ASA was extended by four and one-half years and will now expire July 1, 2022.

In connection with the acquisition of Mesaba, the Company modified its CPAs with Delta to provide for a rate adjustment that was to be effective the date that the Company implemented a combined collective bargaining agreement covering both Pinnacle’s and Mesaba’s pilots, which was February 17, 2011 (the “Pilot Rate Reset”).  This rate adjustment was intended to increase Pinnacle’s rates as a result of the increase in pilot labor costs related to Pinnacle’s Delta operations.  The rate adjustment was to be calculated and agreed to by the Company and Delta looking back after 12 months after the effective date of the new collective bargaining agreement, or February 17, 2012.  After review and agreement, the Company would receive a one-time retroactive adjustment related to the prior 12 months for the increase in its pilot costs, as well as a prospective adjustment to the rates payable for future periods.  In addition, a negotiated reset of the rate-based payments the Company receives under its CRJ-200 ASA and its Mesaba CRJ-900 DCA was set to occur at the beginning of 2013 (the “2013 Rate Reset”).  This rate reset was designed to adjust the Company’s rate based compensation under the CRJ-200 ASA and the Mesaba CRJ-900 DCA to equal its actual and projected costs (excluding pilot-related costs) under those CPAs at that time.  The A&R CRJ-200 ASA eliminated the provision for both the Pilot Rate Reset and the 2013 Rate Reset.

To the extent that we 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.  Delta may also make changes to our daily aircraft utilization, which can have a material impact on our financial performance.

Upon a change of control of the Company, Delta has both the option to remove up to 70 aircraft from Pinnacle over a three-year period and the option to extend the A&R CRJ-200 ASA for another five years without the obligation to reset rates. In addition, certain operating performance measurement formulas would be revised in Delta’s favor.

 
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Delta may terminate the A&R CRJ-200 ASA at any time for cause, which is defined as:

·  
our failure to make any payment under any CRJ-200 aircraft lease or sublease with Delta;
·  
an event of default by us under any aircraft lease or sublease with Delta;
·  
an event of default under any of our other agreements with Delta;
·  
our failure to maintain required insurance coverages;
·  
our failure to comply with Delta’s inspection requirements;
·  
suspension or revocation of our authority to operate as an airline by the Federal Aviation Administration (“FAA”) or the Department of Transportation (“DOT”);
·  
our failure to operate more than 50% of our aircraft for more than seven consecutive days or our failure to operate more than 25% of our aircraft for more than 21 consecutive days, other than as a result of:
o  
an FAA order grounding all commercial flights or all air carriers or grounding a specific aircraft type of all carriers,
o  
a scheduling action by Delta or
o  
Delta’s inability to perform its obligations under the A&R CRJ-200 ASA as a result of a strike by Delta employees;
·  
our failure to comply with certain other requirements contained in the A&R CRJ-200 ASA, including operating performance requirements measured over six-month periods, to the extent such requirements remain uncured after any applicable grace period.

 Delta may also terminate the agreement for any breach of the agreement by us that continues uncured for more than 30 days after we receive notice of the breach.  However, in the case of a non-monetary default, Delta may not terminate the agreement if the default would take more than 30 days to cure and we are diligently attempting to cure the default.  In addition, both Delta and we are entitled to seek an injunction and specific performance for a breach of the agreement.  In addition, in the case of any other termination of the A&R CRJ-200 ASA, Delta will have the right to require us:

·  
to terminate all leases, subleases and agreements with Delta;
·  
to assign, or use our best efforts to assign to Delta, subject to some exceptions, any leases with third parties for facilities at airports to which we primarily fly scheduled flights on behalf of Delta; and
·  
to sell or assign to Delta facilities and inventory then owned or leased by us and used primarily for the services we provide to Delta for an amount equal to the lesser of the fair market value or depreciated book value of those assets.

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 A&R CRJ-200 ASA or caused by our respective actions or inaction under the A&R CRJ-200 ASA.

Pinnacle CRJ-900 Delta Connection Agreement.  As of December 31, 2011, Pinnacle provided regional jet service to Delta through our operation of 16 76-seat CRJ-900 aircraft under the Pinnacle CRJ-900 DCA.  Delta has the option to add, and we have the option to remove, seven CRJ-900 aircraft under the Pinnacle CRJ-900 DCA.

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 provides 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.

On April 1, 2012, Pinnacle Airlines Corp., Pinnacle Airlines, Inc. and Delta entered into a Second Amendment to Delta Connection Agreement (the “Pinnacle CRJ-900 DCA Amendment”).  The Pinnacle CRJ-900 DCA Amendment provides that the Pinnacle CRJ-900 DCA shall terminate in accordance with the following schedule: two (2) aircraft shall be removed from service during January 2013; three (3) aircraft shall be removed from service during each of February, March and April, 2013; and the remaining four (4) aircraft shall be removed from service during May 2013.  Under certain conditions, such removals may be accelerated by Delta.  In addition, the Pinnacle CRJ-900 DCA Amendment modifies rates paid by Delta for services performed by Pinnacle Airlines, Inc., and eliminates the provision for the Pilot Rate Reset.  The Pinnacle CRJ-900 DCA Amendment also includes an agreement between Delta and Pinnacle Airlines, Inc. that Delta shall have an allowed general unsecured claim based on Delta’s damages as a result of the modifications of the Pinnacle CRJ-900 DCA, including without limitation early termination, and the allowed amount of the claim will be subject to the determination and approval of the Bankruptcy Court.

 
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Mesaba CRJ-900 Delta Connection Agreement.  As of December 31, 2011, 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 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.

On April 1, 2012, Pinnacle Airlines Corp., Pinnacle Airlines Inc. and Delta entered into an Amended and Restated 2010 Delta Connection Agreement (the “A&R CRJ-900 DCA”), which amends and restates the Mesaba CRJ-900 DCA.  The A&R CRJ-900 DCA modifies the rates paid by Delta for services performed by Pinnacle Airlines, Inc. and eliminates the provisions for the Pilot Rate Reset and the 2013 Rate Reset.

United Express Q400 Capacity Purchase Agreement.  Pursuant to the Q400 CPA, we operate Q400 turboprop regional aircraft predominantly out of United’s hubs at Newark Liberty International Airport, Washington Dulles, and Houston/George Bush Intercontinental Airport.  As of December 31, 2011, we operated 31 Q400 aircraft under the Q400 CPA.  We also maintained options to purchase an additional 15 Q400 aircraft; however, these options were cancelled in February 2012.
 
The 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 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.

As of February 1, 2012, Pinnacle Airlines Corp. and Colgan entered into an agreement (the “Interim Agreement”) with United, amending the terms of the Q400 CPA for an interim period and setting forth provisions related to possible further modifications to and restructuring of the Q400 CPA.  The term of the Interim Agreement commenced on February 1, 2012 and ended on April 2, 2012.  During this time, United was required to pay certain aircraft ownership expenses and increased rates for our Q400 operations and our former United Pro-Rate Agreements.  Under the Interim Agreement, the services performed under our former United Pro-Rate agreements were operated under provisions substantially identical to the Q400 CPA.

On April 23, 2012, the Bankruptcy Court approved the Final Order authorizing the Company to enter into the previously discussed United Agreement.

Pro-Rate Agreements

As of the date of this filing, the Company no longer operates any flights under Pro-Rate agreements, with the exception of certain Essential Air Service (“EAS”) contracts with the DOT that we operate on behalf of US Airways.  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.  We anticipate exiting the EAS contracts operated under Pro-Rate agreements, which are not material to our business, in June 2012.

 
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Labor costs are a significant component of regional airline expenses and can substantially affect our results.  The follow table details the number of employees by group as of December 31, 2011:

Employee Group
 
Total
 
Pilots
    2,831  
Flight attendants
    1,777  
Ground operations personnel
    1,136  
Mechanics and other maintenance personnel
    1,184  
Dispatchers and crew resource personnel
    378  
Management and support personnel
    491  
Total
    7,797  

As of December 31, 2011, approximately 15% of our employees were part-time employees and approximately 71% of our employees were represented by unions. 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.  Refer to Note 14, Commitments and Contingencies, in Item 8 of this Form 10-K for a table reflecting our principal collective bargaining agreements and their respective amendable dates.


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

The maintenance performed on our aircraft can be divided into three general categories: line maintenance, heavy maintenance checks, and engine and component overhaul and repair. Line maintenance consists of routine daily and weekly scheduled maintenance inspections on our aircraft, including pre-flight, daily, weekly, and overnight checks and any diagnostic and routine repairs.  Heavy maintenance checks involve partial and complete inspection and repair of the airframe while the aircraft is out of service for a prolonged period of time.  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.


We provide training to our flight personnel at our Corporate Headquarters in Memphis, Tennessee and our facility in Minneapolis, Minnesota.  We own and utilize two simulators, one CRJ-200 aircraft simulator and one CRJ-900 aircraft simulator, in Minneapolis.  We also outsource simulators operated by FlightSafety International at various flight simulator centers throughout the U.S. and Canada, as well as simulators operated by the Pan Am International Flight Academy in Minneapolis.

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, particularly when acquiring new aircraft.  We employ professional instructors to conduct training of pilots, mechanics, flight attendants, and ground operations personnel.


We are committed to the safety and security of our passengers and employees.  For example, all of our operating subsidiaries have implemented the Flight Operational Quality Assurance (“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 also 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 adopting the FAA’s Safety Management System (“SMS”).

 
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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, 2012.  We expect to renew the policy upon its expiration.


Our subsidiaries operate under air carrier certificates issued by the FAA and certificates of convenience and necessity issued by the DOT.  Failure to comply with FAA or DOT regulations can result in civil penalties, revocation of the right to operate or criminal sanctions.  For more information concerning these regulations, see Item 1A, Risk Factors, of this Form 10-K.  Also, for more information concerning any unresolved civil penalties, see Note 14, Commitments and Contingencies, in Item 8 of this Form 10-K.


As with most airlines, we are subject to seasonality and cyclicality, which can significantly affect our financial and operating results.  Mainline carriers use CPAs because these arrangements allow them to expand or contract aircraft utilization based upon levels of demand for regional airline services.  Our CPAs with Delta provide for the ability to reduce flying in periods of low demand.


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, should they occur, will be promptly posted to our website.  In addition, information regarding our Chapter 11 filing and reorganization can be found at www.pinnaclerestructuring.com.


If any of the following occurs, our business, financial condition and results of operations could suffer.  We operate in a continually changing business environment.  In this environment, new risks may emerge and already identified risks may vary significantly in terms of impact and likelihood of occurrence. Management cannot predict such developments, nor can it assess the impact, if any, on our business of such new risk factors or of events described in any forward-looking statements.
 
We have identified various risks faced by the organization and aligned these risks with appropriate board level oversight.

RISKS RELATED TO OUR FINANCIAL CONDITION

1.  
Our filing of voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code and our ability to successfully emerge as a stronger, more focused company may be affected by a number of risks and uncertainties.

 
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We are subject to a number of risks and uncertainties associated with the filing of voluntary petitions for relief under Chapter 11 of the Bankruptcy Code, which may lead to potential adverse effects on our liquidity, results of operations and business prospects.  We cannot make any assurances regarding the outcome of the Chapter 11 proceedings.  Risks and uncertainties associated with our Chapter 11 proceedings include the following:

·  
our ability to obtain Bankruptcy Court approval with respect to motions in the Chapter 11 cases and the outcomes of Bankruptcy Court rulings in the case in general;

·  
the length of time that we will operate under the Chapter 11 cases and our ability to successfully emerge from Chapter 11;

·  
our ability to develop and consummate a plan of reorganization with respect to the Chapter 11 cases;

·  
our ability to obtain Bankruptcy Court and creditor approval of our reorganization plan and the impact of alternative proposals, views and objections of the creditors’ committee and other interested parties, which may make it difficult to develop and consummate a reorganization plan in a timely manner;

·  
risks associated with third parties seeking and obtaining court approval to (i) terminate or shorten our exclusivity period to propose and confirm a plan of reorganization; (ii) appoint a Chapter 11 trustee or (iii) convert the Chapter 11 cases to Chapter 7 liquidation cases;

·  
risks associated with third-party motions in the Chapter 11 cases, which may interfere with our reorganization efforts;

·  
the ability to maintain sufficient liquidity throughout the Chapter 11 proceedings;

·  
increased costs related to the Bankruptcy Filing;

·  
our ability to manage contracts that are critical to our operation, to obtain and maintain appropriate terms with customers, suppliers and service providers; and

·  
the outcome of pre-petition claims against us; and our ability to maintain existing customers, vendor relationships and expand our customer base.

These risks and uncertainties could affect our business and operations in various ways. For example, negative events or publicity associated with our Chapter 11 proceedings could adversely affect our relationships with our customers, as well as with vendors and employees, which in turn could adversely affect our operations and financial condition, particularly if the Chapter 11 proceedings are protracted. Also, transactions outside the ordinary course of business are subject to the prior approval of the Bankruptcy Court, which may limit our ability to respond timely to certain events or take advantage of certain opportunities.

Because of the risks and uncertainties associated with our Chapter 11 cases, the ultimate impact of events that occur during the reorganization proceedings on our business, financial condition and results of operations cannot be accurately predicted or quantified.  If any one or more of these risks materializes, it could affect our ability to continue as a going concern.

2.  
There can be no assurance that we will be able to meet our obligations under our debtor-in-possession financing.

In addition to standard financing covenants and events of default provided in similar post-petition credit facilities, the DIP Financing also includes requirements relating to (i) certain milestones that must be met relating to the delivery of a six-year business plan; (ii) the filing and confirmation of a plan of reorganization; and (iii) modifications to collective bargaining agreements through a settlement or relief under Section 1113 of the Bankruptcy Code.

A breach of any of the covenants contained in the DIP Financing, or our inability to comply with the required milestones in the DIP Financing, when applicable, could result in an event of default under the DIP Financing, subject, in certain cases, to applicable grace and cure periods.  If any event of default occurs and we are not able to either cure it or obtain a waiver from Delta, Delta may declare all of our outstanding obligations under the DIP Financing, together with accrued interest and fees, to be immediately due and payable, and further, Delta may terminate its commitment under the DIP Financing, and if applicable, Delta could institute foreclosure proceedings against our pledged assets.  This could adversely affect our operations and our ability to satisfy our obligations as they come due.

 
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3.  
We have substantial liquidity needs and face liquidity pressure.

We have substantial liquidity needs in the operation of our business and face significant liquidity challenges due to the financial difficulties experienced in the airline industry. Accordingly, we believe that our cash and cash equivalents will remain under pressure during 2012 and thereafter. Because substantially all of our assets are encumbered and our DIP Financing contains restrictions against additional borrowing, we believe we will not be able to obtain any material amount of additional debt financing during our Chapter 11 proceedings.

A number of other factors, including our financial results in recent years, our substantial indebtedness, the difficult revenue environment we face, and the financial difficulties experienced in the airline industry, adversely affect the availability and terms of funding that might be available to us during, and upon emergence from, our Chapter 11 cases.  In addition, the global economic downturn resulted in greater volatility, less liquidity, widening of credit spreads, and substantially more limited availability of funding.  As a result of these and other factors, there can be no assurances that we will be able to source capital at acceptable rates and on acceptable terms, if at all, to fund our current operations and our exit from Chapter 11. An inability to obtain necessary additional funding on acceptable terms would have a material adverse impact on us and on our ability to sustain our operations, both currently and upon emergence from Chapter 11.

4.  
Our initiatives to reduce our costs may not be adequate or successful.
 
As we seek to improve our financial condition, we must continue to take steps to reduce our costs during the Chapter 11 proceedings.  Our future plan of reorganization will contain initiatives to reduce our costs and increase our revenues.  We should, however, note that given the structure and long-term nature of our code-share agreements and our relationships with our partners, it is very difficult to identify and implement significant cost savings initiatives.  Moreover, whether our initiatives will be adequate or successful depends in large measure on factors beyond our control, notably the overall industry environment, including passenger demand, yield and industry capacity growth, and labor negotiations.

5.  
The amounts we receive under our operating agreements may be less than the corresponding costs we incur.

Under our CPAs, our partners bear 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 partners are obligated to pay to us amounts at predetermined rates based on the level of capacity that we generate for them.  If our controllable costs continue to exceed our rate-based revenue, our financial results will continue to be adversely affected.  For example, certain CRJ-200 line 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.

6.  
Even if a Chapter 11 plan of reorganization is consummated, continued weakness or worsening of economic conditions could have an adverse affect on our business and financial conditions in ways that we cannot currently predict.

While the stability of the U.S. and global economy remains in question, the financial and credit markets remain at risk, which could depress any prospects for sustainable growth in the airline industry in the near future.  As a result of the ongoing uncertainty in credit markets, particularly as a result of recent credit rating alerts issued by Standard and Poor's on sovereign debt, our access to capital markets to raise capital may be restricted, which could affect our ability to meet our obligations, could create difficulty in reacting to changing economic and business conditions, and could limit our ability to expand our operations.  Additionally, a decline in economic conditions can also impair the ability of our counterparties to satisfy their obligations to us.

7.  
We are often affected by certain factors beyond our control, including weather conditions, which can affect operating performance and financial results.
 
While a significant portion of revenues earned under our CPAs are rate-based and driven by the block hours we operate, our operating agreements with our partners include incentives and penalties that are based upon operating performance.  During periods of adverse weather conditions, flights may be cancelled or significantly delayed.  Such factors can negatively impact our operating performance and preclude us from earning incentives and may result in incurring penalties.

 
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RISKS RELATED TO OUR OPERATING STRATEGY

8.  
We are highly dependent upon our regional airline services agreements with Delta.

We are highly dependent on Delta and United, our largest customers in 2011, which generated approximately 74% and 22%, respectively, of our consolidated regional airline services revenue during the year ended December 31, 2011.  In addition, 41 of our 57 CRJ-900 aircraft and our entire fleet of 141 CRJ-200 aircraft are subleased from Delta under leases that terminate if our airline services agreements with Delta terminate.  By the end of 2012, 100% of our regional airline services revenue will be generated from Delta, and all of our aircraft will be subleased from Delta.  We would be significantly and negatively affected should one of our remaining 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 our 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.  All of our CPAs with Delta contain cross-default provisions.  Therefore, any failure on our part to meet minimum operating performance requirements under any 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.  Any future attempt by Delta 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.

9.  
We are highly dependent upon the services provided by our major airline partners.

We are highly dependent upon our partners for the services they provide to support our current operations.  For example, we currently use or rely upon Delta’s and United’s 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.  Were we to lose any of our operations with these partners, 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.

10.  
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 due to current market conditions, particularly as it relates to volatile fuel costs.  Specifically, they cite an oversupply of 50-seat regional jets under contractual commitments with regional airlines.  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 CPAs.  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.  For example, Delta’s utilization of our 50-seat CRJ-200 aircraft has decreased in recent years, which had a negative impact on our regional airline services revenue and profitability.  Our CPAs with Delta do not contain a provision for a minimum level of utilization.

In an environment where the supply of regional aircraft exceeds the demand from the major airlines, 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.

 
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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, 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.

11.  
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.  While we have in place, and continue to invest in, technology security initiatives and disaster recovery plans, these measures may not be adequate or implemented properly to prevent a business disruption and its adverse financial consequences to our business.

12.  
The airline industry has recently gone through a period of consolidation and transition; consequently, we have fewer potential partners.
 
Since 1978 and continuing to the present, the airline industry has undergone substantial consolidation, and it may undergo additional consolidation in the future.   For example, since 2008, significant mergers have been executed between AirTran Airways and Southwest Airlines, Continental and United, and Delta and Northwest Airlines.  We, as well as our partners, routinely monitor changes in the competitive landscape and engage in analysis and discussions regarding our strategic position.  Further consolidation could limit the number of potential partners with whom we could enter into code-share relationships.

13.  
We may be limited from expanding our flying within our partners’ flight systems, and there are constraints on our ability to provide airline services to other airlines.

Additional growth opportunities within our partners’ flight systems are limited by various factors. Except as currently contemplated by our existing code-share agreements, we cannot assure that our partners will contract with us to fly any additional aircraft. We may not receive additional growth opportunities, or may agree to modifications to our code-share agreements that reduce certain benefits to us in order to obtain additional aircraft, or for other reasons. Furthermore, difficult financial conditions or significant restructurings at Delta may reduce the growth of regional flying within Delta’s flight systems. Given the volatile nature of the airline industry, we believe that some of our competitors may be more inclined to accept reduced margins and less favorable contract terms in order to secure new or additional code-share operations. Even if we are offered growth opportunities by our major partners, those opportunities may involve economic terms or financing commitments that are unacceptable to us. Any one or more of these factors may reduce or eliminate our ability to expand our flight operations with our existing code-share partners. Additionally, even if our partners choose to expand our fleet on terms acceptable to us, they may be allowed at any time to subsequently reduce the scope of our operations, which could result in a reduction in the block hours we operate and/or the number of aircraft covered by our code-share agreements.  We also cannot provide any assurance that we will be able to obtain the additional ground and maintenance facilities, including gates, and support equipment, to expand our operations. The failure to obtain the facilities and equipment required would likely impede our efforts to implement our business strategy and could materially and adversely affect our operating results and our financial condition.

Our partners may be restricted in increasing their business with us, due to “scope” clauses in the current collective bargaining agreements with their pilots that restrict the number and size of regional jets that may be operated in their flight systems not flown by their pilots.  For example, Delta’s scope limitations restrict its partners from operating aircraft with over 76 seats, even if those aircraft are operated for an airline other than Delta. We cannot assure that these scope clauses will not become more restrictive in the future.

 
18

 
 
 
Our business model depends on major airlines electing to contract with us instead of operating their own regional jets. Some major airlines, including Delta, American, and Alaska, own their own regional airlines or operate their own regional jets instead of entering into contracts with regional carriers. We have no guarantee that in the future our code-share partners will choose to enter into contracts with us instead of operating their own regional jets. Our partners are not prohibited from doing so under our code-share agreements. A decision by Delta to phase out code-share relationships and instead operate their own regional jets could have a material adverse effect on our financial condition, results of operations or the price of our common stock.

Additionally, our code-share agreements limit our ability to provide airline services to other airlines in certain major airport hubs of each of our partners.  Due to the fluctuations in our schedules, which are established primarily by our major partners, there may be times that the number of flights we fly to and from a particular airport may exceed the limitations set forth in one or more of our code-share agreements. The breach of those limitations could constitute a breach of the applicable code-share agreement, which could have a material adverse effect on our operations.

RISKS RELATED TO LABOR

14.  
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 of our total operating costs, ranging from approximately 30% to 35%, and it is estimated that this number will increase to 40% to 45% by 2013.  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, 2011, 71% of our employees were unionized.  Increases in our unionized labor costs may potentially result in a material reduction to our earnings, and could affect our future prospects for additional business opportunities.

For example, on February 17, 2011, we entered into the ALPA JCBA, which materially increased our pilots’ salaries, wages, and benefits costs.

15.  
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.

In connection with our Chapter 11 cases, we will be seeking wage reductions and other concessions from our labor unions in order to ensure the viability of our business.  While we hope that consensual agreements can be reached with each of our unions, an inability to reach agreement with union representatives or otherwise gain such concessions would significantly impair our ability to reorganize and successfully emerge from Chapter 11.

16.  
If we are unable to attract and retain key employees, our operating performance and financial results 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.

 
19

 


Similarly, as we focus on integrating our operations, which can place significant strains on an organization, 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 could be forced to cancel flights and forego earning incentive-based revenue under our code-share agreements while conversely incurring performance penalties.
 
RISKS RELATED TO SAFETY AND COMPLIANCE

17.  
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, mandates stricter rules to minimize pilot fatigue, and includes other regulatory mandates.

18.  
Failure to comply with FAA or DOT regulations could result in civil penalties, the grounding of our operations, the revocation of our right to operate, and damage to our reputation with our current code-share partners as well as potential code-share partners, all of which could negatively impact our financial results and our ability to operate as a going concern.

Our subsidiaries operate under air carrier certificates issued by the FAA and certificates of convenience and necessity issued by the DOT.

FAA regulations are primarily in the areas of flight operations, maintenance, ground facilities, transportation of hazardous materials, and other technical matters. The FAA may issue fines, suspend or revoke the air carrier certificate of any one of our subsidiaries if we fail to comply with the terms and conditions of the certificates. 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.  For example, during the year ended December 31, 2011, we have incurred $1.3 million in expenses associated with FAA inspections.

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. The DOT may alter, amend, modify or suspend our operating certificates if the DOT determines that we are no longer fit to continue operations.  Although we believe we are in compliance with all applicable FAA requirements at this time, those requirements change over time, as does the age of our aircraft equipment, requiring ongoing compliance efforts by the Company.

19.  
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.

20.  
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.  We continue to follow any developments of the regulatory programs in both the United States and other areas that we operate our business. Climate change-related regulatory activity in future periods may adversely affect our business and financial results.

None.

 
20

 




The following table displays our aircraft fleets as of December 31, 2011.
 
Aircraft Type
 
Number of Aircraft Leased
 
Number of Aircraft Owned
 
Total
Aircraft
 
Standard Seating Configuration
CRJ-200
 
141
 
-
 
141
 
50
CRJ-900
 
41
 
16(1)
 
57
 
76
   Total regional jets
 
182
 
16
 
198
   
Q400(2)
 
3(3)
 
28
 
31
 
74
Saab 340B(4)
 
26(5)
 
23
 
49
 
34
   Total turboprops
 
29
 
51
 
80
   
   Total aircraft
 
211
 
67
 
278
   
 
(1)
As discussed in Item 1, we will wind down operations using these aircraft during the first half of 2013.
(2)
As discussed in Item 1, in connection with our Chapter 11 filing, we abandoned the 28 owned Q400s and rejected the leases on the leased Q400 aircraft.  We continue to operate a portion of this fleet, but will wind down operations using these aircraft during 2012 and do not expect to operate any by the end of 2012.
(3)
Includes one spare Q400 aircraft that we utilized under an operating lease.
(4)
As discussed in Item 1, in connection with our Chapter 11 filing, we rejected the leases on the leased Saab aircraft.  We continue to operate a portion of this fleet, but we are winding down operations using these aircraft during 2012 and do not expect to operate any by the end of July 2012.
(5)
In December 2011, we ended our US Airways operations at New York-LaGuardia and, as of December 31, 2011, we ceased use of seven Saab 340B+ aircraft, which we utilized under operating leases with expiration dates through January 2015.  Refer to Note 5, Special Items, in Item 8 of this Form 10-K, for more details regarding the exit liability associated with the seven aircraft.  Also, as of December 31, 2011, we had ten Saab 340B+ aircraft that were no longer in operation under the Delta Saab DCA and remained in the lease return process.


Our corporate offices are located in Memphis, Tennessee.  In 2011, we relocated our corporate offices from the airport area to downtown Memphis, where we occupy office space under a 13-year lease that expires in 2024.  One of the considerations influencing the decision to make this move was a commitment by the state of Tennessee to pay us certain tax incentives.  As of the date of this filing, we have not received payment of any of these incentives.  We also lease office and flight simulator training space in Minneapolis, Minnesota, under a lease that expires in November 2016.

Our hangar and maintenance facilities are located in cities that we serve based on market size, frequency, and location.  We believe that our existing facilities are adequate for our fleet.  As our fleet and route structure change, we may make modifications to our maintenance operations,

We currently lease ten hangar facilities located in Memphis, Tennessee; Washington-Dulles; Minneapolis, Minnesota; Detroit, Michigan; Houston, Texas; Albany, New York; Knoxville, Tennessee; Des Moines, Iowa; Fort Wayne, Indiana; and Mosinee, Wisconsin.  These leases expire on various dates.  We also own one aircraft hangar facility in Mosinee, Wisconsin.  The rents associated with three of these hangar facilities are reimbursed by Delta.

We currently lease six line maintenance facilities located in Atlanta, Georgia; New York City-John F Kennedy; Newark, New Jersey; Austin, Texas; Greenville, South Carolina; and Indianapolis, Indiana.

In connection with our code-share agreements, we maintain contract service agreements with our partners allowing for the use of terminal gates, parking positions, and operations space at airports we serve on behalf of our customers.  We believe the use of the terminal gates, parking positions, and operations space obtained from our code-share partners as well as our leased office space and maintenance facilities will be sufficient to meet the operational needs of our business.

 
21

 




The Company and its subsidiaries are defendants in various ordinary and routine lawsuits incidental to our business. While the outcome of these lawsuits and proceedings 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 suits will not have a material adverse effect on our consolidated financial statements as a whole.  For further discussion, refer to Note 14, 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.

Chapter 11 Filing.  Please refer to Item 1, Business, for a discussion of the Bankruptcy Filing.


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.


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.


Not applicable.


 
22

 

 
Part II
 

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

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 NASDAQ.  Following our initial public offering, our common stock began trading on November 25, 2003 on the NASDAQ Global Select Market under the symbol “PNCL.”  On April 11, 2012, our stock was delisted from NASDAQ and began trading on the Pink OTC Markets Inc. under the symbol “PNCLQ.”

2011
 
High
   
Low
 
First quarter
  $ 8.64     $ 5.26  
Second quarter
  $ 6.06     $ 4.05  
Third quarter
  $ 4.67     $ 2.77  
Fourth quarter
  $ 3.10     $ 0.82  

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  

As of May 21, 2012, there were approximately 31 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.

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.

 
23

 


The following graph compares total shareholder return on the Company’s common stock over the five-year period ending December 31, 2011, 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, 2006. The graph below represents historical stock performance and is not necessarily indicative of future stock price performance.
 
 


 
24

 


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 Results 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,
 
   
2011
   
2010
   
2009
   
2008
   
2007
 
Statement of Operations Data:
 
(in thousands, except per share data)
 
                               
Total operating revenues(1)
  $ 1,232,365     $ 1,020,767     $ 845,508     $ 864,785     $ 787,374  
Total operating expenses (2)
    1,231,230       959,234       764,799       819,178       734,963  
Operating income
    1,135       61,533       80,709       45,607       52,411  
Nonoperating expense(3)
    (47,239 )     (40,650 )     (38,471 )     (54,196 )     (8,462 )
Income tax benefit (expense)(4)
    14,626       (8,113 )     (382 )     (2,408 )     (13,526 )
Net income (loss)
    (31,478 )     12,770       41,856       (10,997 )     30,423  
Basic earnings (loss) per share
   $ (1.70 )    $ 0.70      $ 2.33      $ (0.62 )    $ 1.46  
Diluted earnings (loss) per share
   $ (1.70 )    $ 0.69      $ 2.31      $ (0.62 )    $ 1.32  
Shares used in computing basic earnings (loss) per share
    18,481       18,132       17,969       17,865       20,897  
Shares used in computing diluted earnings (loss) per share
    18,481       18,558       18,133       17,865       23,116  
                                         

(1)
Operating revenues were affected by the July 1, 2010 acquisition of Mesaba as well as the purchase of 16 Q400s during 2010 and 2011.  For more information regarding the Acquisition, refer to Note 15, Acquisition of Mesaba, in Item 8 of this Form 10-K.
(2)
Operating expenses for the year ended December 31, 2011 were adversely affected by the new collective bargaining agreement with our pilots, scheduling changes by our code-share partners, and special items charges.  Refer to Note 5, Special Items, for more details regarding special items charges.  Operating expenses were also affected by the July 1, 2010 acquisition of Mesaba as well as the purchase of 16 Q400s during 2010 and 2011.  For more information regarding the Acquisition, refer to Note 15, 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.
(3)
Nonoperating expense for the year ended December 31, 2008 includes a $16.8 million impairment charge on our ARS investments.
(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 13, Income Taxes, in Item 8 of this Form 10-K.
 


 
25

 

Item 6. Selected Financial Data (continued)
 
   
As of December 31,
 
Balance Sheet Data:
 
2011
   
2010(1)
   
2009
   
2008
   
2007
 
   
(in thousands)
 
                               
Cash and cash equivalents
  $ 66,317     $ 100,084     $ 91,574     $ 69,469     $ 26,785  
Investments
    1,049       1,852       2,723       116,900       186,850  
Property and equipment, net
    998,803       935,138       731,073       719,931       257,168  
Total assets (2)
    1,475,416       1,498,798       1,289,420       1,127,702       699,548  
Long-term debt obligations, including leasing arrangements
    720,553       667,875       521,961       603,026       174,208  
Stockholders' equity
    89,669       119,493       102,237       55,734       71,054  
                                         
 
(1)
The balance sheet as of December 31, 2010 was affected by the July 1, 2010 acquisition of Mesaba.  For more information regarding the Acquisition, refer to Note 15, Acquisition of Mesaba, in Item 8 of this Form 10-K.
(2)
For the years ended December 31, 2011, 2010, and 2009, total assets include approximately $235 million, $275 million, and $300 million, respectively, of 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 14, Commitments and Contingencies, in Item 8 of this Form 10-K.
 
   
Years Ended December 31,
 
   
2011
   
2010(1)
   
2009
   
2008
   
2007(1)
 
                               
Other Data:
                             
Revenue passengers (in thousands)
    20,001       16,391       13,473       12,926       11,494  
Revenue passenger miles (“RPMs”) (in thousands) (2)
    8,673,702       6,942,182       5,281,461       5,420,673       4,898,188  
Available seat miles (“ASMs”) (in thousands) (3)
    11,589,719       9,438,766       7,204,094       7,380,490       6,604,082  
Passenger load factor (4)
    74.8 %     73.5 %     73.3 %     73.4 %     74.2 %
Operating revenue per ASM (in cents)
    10.63       10.81       11.74       11.72       11.92  
Operating revenue per block hour
    1,529       1,481       1,498       1,451       1,392  
Operating cost per ASM (in cents)
    10.62       10.16       10.62       11.10       11.13  
Operating cost per block hour
    1,528       1,391       1,355       1,375       1,300  
Block hours
                                       
       Regional jets
    598,364       523,148       426,432       442,911       438,988  
       Turboprops
    207,531       166,291       138,166       152,890       126,675  
Departures
                                       
       Regional jets
    365,876       326,751       273,077       267,893       265,418  
       Turboprops
    158,880       134,137       110,568       121,635       107,171  
Average daily utilization (in block hours)
                                       
       Regional jets
    8.17       8.32       8.26       8.75       8.73  
       Turboprops
    7.02       7.11       7.84       7.86       7.32  
Average stage length (in miles)
    413       402       374       396       321  
Number of operating aircraft (end of period)
                                       
       Regional jets
    198       202       142       142       138  
       Turboprops
    63       81       48       51       47  
Employees
    7,797       7,619       5,106       5,644       5,316  

(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.


 
26

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


On April 1, 2012 (the “Petition Date”), Pinnacle Airlines Corp. and its subsidiaries (collectively, the “Company” or the “Debtors”) filed voluntary petitions for relief (the “Bankruptcy Filing”) under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”), case number 12-11343-REG.  The Debtors will continue to operate their businesses as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court.

The Bankruptcy Filing is intended to permit the Company to reorganize and improve liquidity, reduce costs, wind down unprofitable contracts and focus on the most valuable business lines to enable sustainable profitability.  The Company’s goal is to develop and implement a reorganization plan that meets the standards for confirmation under the Bankruptcy Code.  Confirmation of a reorganization plan could materially alter the classifications and amounts reported in the Company’s consolidated financial statements, which do not give effect to any adjustments to the carry values of assets or amounts of liabilities that might be necessary as a consequence of confirmation of a reorganization plan or other arrangement or the effect of any operational changes that may be implemented.

Operation and Implication of the Bankruptcy Filing

Under Section 362 of the Bankruptcy Code, the filing of voluntary bankruptcy petitions by the Debtors automatically stayed most actions against the Debtors, including most actions to collect indebtedness incurred prior to the Petition Date or to exercise control over the Debtors’ property.  Accordingly, although the Bankruptcy Filing triggered defaults for certain of the Debtors’ debt and lease obligations, counterparties are stayed from taking any actions as a result of such defaults.  Absent an order of the Bankruptcy Court, substantially all of the Company’s pre-petition liabilities are subject to settlement under a reorganization plan.  As a result of the Bankruptcy Filing, the realization of assets and the satisfaction of liabilities are subject to uncertainty.  The Debtors, operating as debtors-in-possession under the Bankruptcy Code, may, subject to approval of the Bankruptcy Court, sell or otherwise dispose of assets and liquidate or settle liabilities for amounts other than those reflected in the consolidated financial statements.  Further, a confirmed reorganization plan or other arrangement may materially change the amounts and classifications in the Company’s consolidated financial statements.

Subsequent to the Petition Date, the Debtors received approval from the Bankruptcy Court to pay or otherwise honor pre-petition obligations generally designed to stabilize the Company’s operations.  These obligations relate to certain employee wages, salaries and benefits, and payments to fuel counterparties and other service providers in the ordinary course for goods and services received after the Petition Date.  The Debtors have retained, subject to Bankruptcy Court approval, legal and financial professionals to advise the Debtors in connection with the Bankruptcy Filing and certain other professionals to provide services and advice in the ordinary course of business.  From time to time, the Debtors may seek Bankruptcy Court approval to retain additional professionals.

The U.S. Trustee for the Southern District of New York has appointed an official committee of unsecured creditors (the “UCC”).  The UCC and its legal representatives have a right to be heard before the Bankruptcy Court on matters affecting the Debtors.  There can be no assurance that the UCC will support the Debtors’ positions on matters to be presented to the Bankruptcy Court in the future or on any reorganization plan.

Reorganization Plan

In order for the Company to emerge successfully from Chapter 11, the Company must obtain the Bankruptcy Court’s approval of a reorganization plan, which will enable the Company to transition from Chapter 11 into ordinary course operations outside of bankruptcy.  In connection with a reorganization plan, the Company also may require a new credit facility, or “exit financing.”  The Company’s ability to obtain such approval and financing will depend on, among other things, the timing and outcome of various ongoing matters related to the Bankruptcy Filing.  A reorganization plan determines the rights and satisfaction of claims of various creditors and parties-in-interest, and is subject to the ultimate outcome of negotiations and Bankruptcy Court decisions ongoing through the date on which the reorganization plan is confirmed.

 
27

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

The Company presently expects that any proposed reorganization plan will provide, among other things, mechanisms for settlement of claims against the Debtors’ estates, treatment of the Company’s existing equity and debt holders, and certain corporate governance and administrative matters pertaining to the reorganized Company.  Any proposed reorganization plan will be subject to revision prior to submission to the Bankruptcy Court based upon discussions with the Company’s creditors and other interested parties, and thereafter in response to interested parties’ objections and the requirements of the Bankruptcy Code and Bankruptcy Court.  There can be no assurance that the Company will be able to secure approval for the Company’s proposed reorganization plan from the Bankruptcy Court or that the Company’s proposed reorganization plan will be accepted by the lender under the DIP Financing, as discussed below.  In the event that the Company does not secure approval of the proposed reorganization plan, the Company’s outstanding principal and interest obligations could become immediately due and payable.

Agreements with United Airlines and Export Development Canada

Since 2007, Colgan has performed regional air services for Continental Airlines, Inc. (“Continental”) with respect to Q400 aircraft predominantly out of Continental’s hub at Newark Liberty International Airport pursuant to a capacity purchase agreement (the “Q400 CPA”) and related ancillary agreements related to fuel and ground handling, each dated as of February 2, 2007 (together with the Q400 CPA, collectively, the “Prior Agreements”).  Pinnacle Airlines Corp. guaranteed Colgan’s obligations under the Prior Agreements pursuant to the Guarantee Agreement, dated as of February 2, 2007 (the “Continental Guarantee”).

The Q400 CPA provided for Colgan to be compensated at pre-set rates for the capacity that it provided to Continental.  Colgan was responsible for its own expenses associated with flight crews, maintenance, dispatch, aircraft ownership, and general and administrative costs.  In addition, Continental reimbursed Colgan without markup for certain reconciled costs, such as landing fees, most station-related costs not otherwise provided by Continental or its designee, aircraft hull and passenger liability insurance (subject to certain requirements) and passenger-related costs.

On April 23, 2012, the Bankruptcy Court granted the Debtors final approval pursuant to court order [ECF No. 173] (the “Final Order”) to reject the Prior Agreements and to terminate the Continental Guarantee, as more fully described below.  The Final Order also authorized the Debtors to enter into the New Agreements (as defined below).

United Agreement

The Final Order authorized the Debtors to perform their obligations under a term sheet (the “United Agreement”) among Pinnacle Airlines Corp., Colgan, Continental Airlines, Inc., United Air Lines, Inc. (together with Continental Airlines, Inc., “United”) and Export Development Canada (“EDC”).  The material terms of the United Agreement include:

·  
The term of the United Agreement commenced on April 3, 2012 and will end on November 30, 2012, unless otherwise agreed by the Debtors and United.
·  
During the term of the United Agreement, United shall pay increased rates for Colgan’s provision of regional air services related to Colgan’s Q400 and Saab aircraft on terms otherwise substantially similar to those contained in the Prior Agreements, which have been rejected by the Debtors in connection with their Chapter 11 proceedings, as more fully described below.
·  
The regional air services provided to United will be wound down gradually over the term of the United Agreement, with the first three Q400 aircraft and the first five Saab aircraft being wound down in May 2012.  It is anticipated that the regional air services provided by the Saab aircraft and the Q400 aircraft will be fully wound down by July 31, 2012 and November 30, 2012, respectively.
·  
United will pay EDC directly for Colgan’s continued use of each Q400 aircraft and related aircraft equipment financed by EDC (the “Q400 Covered Equipment”) until such aircraft are wound down in accordance with the United Agreement, pursuant to terms separately agreed by United and EDC.  Colgan will remain responsible for insuring the Q400 Covered Equipment during its period of continued use.
·  
Pinnacle Airlines Corp. guarantees Colgan’s obligations under the United Agreement.

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

 
EDC Agreement

The Final Order also authorized the Debtors to perform their obligations under a term sheet (the “EDC Agreement,” and together with the United Agreement, the “New Agreements”) among Pinnacle Airlines Corp., Colgan, EDC and United.  The material terms of the EDC Agreement include:

·  
As of the Petition Date, Colgan shall be deemed to have returned to EDC all Q400 Covered Equipment used to perform the regional air services under the United Agreement.
·  
EDC waived its right to seek administrative expense claims against the Debtors in connection with such return but reserved its right to seek administrative expense claims against the Debtors in connection with any breach of the EDC Agreement itself.
·  
Colgan shall be entitled to use such Q400 Covered Equipment in connection with its provision of regional air services under the United Agreement.
·  
Upon the wind-down of any such Q400 Covered Equipment under the United Agreement, Colgan is required to physically return such Q400 Covered Equipment to EDC.  Upon such return, EDC is authorized to dispose of such Q400 Covered Equipment without the consent of the Debtors.

Debtor-in-Possession Financing

In connection with the Company’s Chapter 11 cases, on May 18, 2012, the Company and Delta entered into a debtor-in-possession credit agreement pursuant to which Delta agreed to provide $74,285,000 in secured debtor-in-possession financing (“DIP Financing”) to Pinnacle Airlines Corp., guaranteed by Pinnacle Airlines Corp.’s subsidiaries.  Such DIP Financing was approved by final order of the Bankruptcy Court on May 17, 2012 [ECF No. 316].

The DIP Financing has a term of one year from the date of the filing of the Company’s Chapter 11 cases (subject to early termination in certain instances) and accrues interest at the rate of 12.5% per annum.  There is no additional fee payable to Delta in connection with the DIP Financing.  The DIP Financing contains customary default provisions, and certain milestones that must be met relating to the delivery of a six-year business plan, filing and confirmation of a plan of reorganization and modifications to collective bargaining agreements through a settlement or relief under Section 1113 of the Bankruptcy Code.  Approximately $46.2 million of the DIP Financing was used to repay Delta’s existing secured promissory note and the balance of the DIP Financing is additional available working capital for the Company.  If certain conditions are satisfied, including substantial consummation of a plan of reorganization that is reasonably acceptable to Delta and the absence of a continuing or unwaived default or event of default, Delta has agreed to convert the DIP Financing into a senior secured exit financing facility.


Following significant operating losses in 2008, we were able to improve our operating performance in 2009. In 2010, we increased our revenue, bolstered by the acquisition of Mesaba from Delta/Northwest, although overall profitability decreased.  We had anticipated improvements and continued growth in 2011. However, as discussed below, 2011 and first quarter 2012 presented severe challenges, ultimately culminating in the Bankruptcy Filing.  The Company underwent significant changes in senior management in 2011, including the resignations of the CEO and CFO in March 2011 and June 2011, respectively. In July 2011, the Company hired a new CEO and a new CFO.  The new CEO spearheaded a thorough assessment of our business to identify areas of vulnerability and opportunities for improvement. This assessment revealed five critical factors that had combined to jeopardize the Company’s viability: (1) delays in integrating the operating certificates of our subsidiaries; (2) developments arising out of a new, joint collective bargaining agreement with our pilots; (3) increasingly unprofitable contracts with airline customers; (4) poor operational performance; and (5) increased operational expenses. These factors are discussed individually below.

Delayed Integration and Synergies. Upon the acquisition of Mesaba in mid-2010, we had intended to consolidate our jet and turboprop flying into two operating certificates as quickly as possible, instead of retaining a separate operating certificate for each of the three airline subsidiaries. Maintaining an additional operating certificate imposes various redundant costs and inefficiencies.

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



The consolidation process, however, proved substantially more difficult and time-consuming than anticipated. The Mesaba jet operation was originally scheduled to be moved under the Pinnacle operating certificate in May 2011, but delays in obtaining FAA approval delayed this move until January 2012. As a result, the anticipated cost savings were deferred, and we had to expend substantial additional resources, including hiring additional employees and consultants, to accomplish the consolidation. Additionally, the management structure in place prior to a January 2012 reorganization to streamline the structure was not conducive to realizing the efficiencies of consolidation.

Although the Mesaba jets have been moved under the Pinnacle operating certificate as of the date of this filing, full integration of maintenance and flight operations of Pinnacle and Mesaba jets is not expected to be completed until early 2013. We estimate that we have incurred unanticipated costs and lost revenue in the tens of millions of dollars as a result of delayed integration and lost synergies.

ALPA Collective Bargaining Agreement.  In February 2011, the Company signed a collective bargaining agreement with the Air Line Pilots Association, International (“ALPA”), the joint representative of our pilots across all of our subsidiaries. This new agreement (the “ALPA JCBA”) united approximately 3,000 pilots under a single agreement and provided significantly enhanced pay, benefits and work rules.  Compensation of our pilots is currently above market average with respect to wages, benefits, and work rules. In addition to the ALPA JCBA’s compensation provisions, the integration of the three pilot groups resulted in unforeseen and substantial complexities and expense stemming from the creation of an “integrated seniority list” (“ISL”). Before the integration, the pilots of each of our three airline subsidiaries were represented by separate ALPA merger committees and each of our three airline subsidiaries maintained its own, separate list ranking the subsidiary’s pilots by seniority. The ALPA merger committees utilized an arbitration process to resolve the differences among the three committees regarding the methodology by which the three pilot lists would be integrated.   The arbitration decision (the “Bloch Ruling”) implementing the ISL merged the three lists, creating a single, integrated list across all subsidiaries,  resulting in new relative seniority relationships among thousands of pilots.

The implementation of the ISL following the Bloch Ruling has had severe, disruptive and expensive consequences on the filling of pilot vacancies and associated training costs. Pilots are permitted to “bid” on vacancies (e.g., to obtain a new domicile, new aircraft, new category), and those bids are honored according to seniority. Each time a pilot moves to fill a vacancy, his or her prior position becomes vacant and must be filled in the same manner. Pilots must undergo training every time they move to a new aircraft or category, and they are entitled under the ALPA JCBA to receive their full salary during training, during which time they are not flying. Before the integration, pilots could bid only on vacancies within their own particular airline.  After the integration, pilots were allowed to bid across all three airlines, precipitating an overwhelming number of transfer requests across a substantially more disparate set of routes and fleet types. The ALPA JCBA contains minimal effective safeguards against the increased training costs imposed by such transfers, and the Bloch Ruling did not establish a sufficient number of “protected” pilot positions to provide meaningful “fences” preventing pilots from freely transferring among the airlines.

The volume of training has been further impacted by the delayed operating certificate integration issues discussed above.  Pilots must be trained not only for transfers to different aircraft, but also transfers to the same aircraft type if it flies under a different operating certificate.  Thus, the delays in operating certificate consolidation described above have further increased the amount of required training.  Training has also increased as a result of flying reductions. As discussed below, we have been working to eliminate unprofitable routes and aircraft types. While essential to our viability, these reductions have further substantially increased the number of pilot re-assignments and associated training costs. This is because pilot terminations are based on “juniority,” meaning that relatively senior pilots displaced by flying reductions must be reassigned to other routes and aircraft flown by more junior pilots. Each reassignment requires costly retraining (often of multiple pilots), with accompanying grounding of the pilot(s) at full salary for non-productive time. This issue was particularly acute in the case of our recent elimination of Mesaba Saab flying for Delta, given the significantly greater relative seniority of Mesaba pilots, and their ability to transfer freely into other subsidiaries after creation of the ISL.

The lack of meaningful ISL fences, integration delays and flying downsizing have resulted in substantial additional training costs and decreased productivity.

Unprofitable Contracts.  A detailed review undertaken in the latter half of 2011 also revealed that the non-compensable costs incurred by the Company under our customer agreements, including certain of the substantially increased labor costs resulting from the ALPA JCBA, as well as maintenance and other expenses related to an aging fleet, were exceeding, or would soon begin to exceed, the fees received under these contracts. In the aggregate, we were incurring losses on our partner contracts.

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

 
 More specifically, it was determined that none of the Saab Pro-Rate flying was profitable. Nor was the Q400 CPA with United viable at the rates being paid. Two of three CPAs with Delta covering CRJ-200s and CRJ-900s were deemed potentially viable, but not without the benefit of contractual rate increases scheduled to be introduced over the course of 2012-2013, which would require extensive negotiations with Delta. In the interim, these contracts were being impacted by the new pilot wage rates and unforeseen expenses associated with the vacancy bidding process under the ALPA JCBA, along with incremental costs associated with an aging fleet.

           Operational Performance and Expenses.  Beginning in the fall of 2010, Pinnacle’s operating performance began to decline, due primarily to a pilot staffing shortage. Colgan’s operating performance also suffered due to new Q400 hub operations in Washington, D.C., Cleveland, and Houston, which imposed significant maintenance and crew expenses that were not recoverable under Colgan’s Q400 CPA agreement with United. For the first six months of 2011, we incurred contract penalties totaling approximately $3.4 million associated with poor performance by Pinnacle and Colgan.


The following represents our consolidated results of operations for the years ended December 31, 2011, 2010 and 2009 (in thousands).

   
Years Ended December 31,
 
   
2011
   
% Change
2011 - 2010
   
2010
   
% Change
2010 - 2009
   
2009
 
                               
Total operating revenue
  $ 1,232,365       21 %   $ 1,020,767       21 %   $ 845,508  
Total operating expenses
    1,231,230       28 %     959,234       25 %     764,799  
Operating income
    1,135       (98 ) %     61,533       (24 )%     80,709  
Operating margin
    0.1 %             6.0 %             9.5 %
Total nonoperating expense
    (47,239 )     16 %     (40,650 )     6 %     (38,471 )
Income (loss) before income taxes
    (46,104 )     (321 )%     20,883       (51 )%     42,238  
Income tax benefit (expense)
    14,626       (280 )%     (8,113 )     2,024 %     (382 )
Net income (loss)
  $ (31,478 )     (346 )%   $ 12,770       (69 )%   $ 41,856  


The following summarizes certain nonrecurring items affecting our results for the years ended December 31, 2011, 2010, and 2009 (in thousands):
 
   
Years Ended December 31,
 
   
2011
   
2010
   
2009
 
   
Pre-tax
   
After Tax
   
Pre-tax
   
After Tax
   
Pre-tax
   
After Tax
 
Integration, severance and contract implementation expenses
  $ 11,907     $ 7,505     $ 10,873     $ 6,839     $ -     $ -  
Impairment and other fleet retirement charges
    14,677       9,265       -       -       1,980       1,219  
Restructuring expenses
    1,931       1,221       -       -       -       -  
Total special items
  $ 28,515     $ 17,991     $ 10,873     $ 6,839     $ 1,980     $ 1,219  


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


Integration, Severance, and Contract Implementation Expenses

2011 - Upon our acquisition of Mesaba on July 1, 2010, we announced an integration plan to transition all jet operations to Pinnacle, and to combine Colgan’s and Mesaba’s turboprop operations.  During 2011, we began implementing the integration plan, which resulted in integration expenses of $11.9 million during 2011.  Integration expenses include training, relocation and displacement of 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. Integration expenses during 2011 included severance expenses of $2.6 million. In addition, we incurred $3.0 million associated with the resignation of our former Chief Executive Officer in March 2011, including the accrual of payments related to a two-year consulting agreement (which was subsequently rejected in connection with our Bankruptcy Filing), as well as the accelerated vesting of stock options and restricted stock awards.  Lastly, during 2011, we incurred $2.9 million of contract implementation costs associated with the implementation of new collective bargaining agreements with our pilots and Pinnacle’s flight attendants.

2010 – In February 2011, we entered into the ALPA JCBA, which covers pilots at all three of the Company’s airline subsidiaries.  The agreement: (1) increased compensation for the Company’s pilots; (2) included a one-time signing bonus of $10.1 million ($10.9 million inclusive of related payroll taxes); and (3) will become amendable on February 17, 2016.  The Company recognized the expense associated with the one-time signing bonus in the fourth quarter of 2010.

Impairment and Other Fleet Retirement Charges

2011 – During the fourth quarter of 2011, we incurred $14.7 million in impairment charges and other charges related to the retirement of our Saab fleet.  In December 2011, we ended our US Airways operations at New York-LaGuardia and, as of December 31, 2011, we had ceased using the seven Saab 340B+ aircraft, which we leased under operating leases with expiration dates through January 2015.  While a definitive plan was not reached as of year-end to dispose of those Saab assets that we own, management reevaluated the remaining useful life and residual value of the Saab assets, determining that we had excess spare parts and supplies, operating leases for which there was no related economic benefit, and projected undiscounted cash flows that were insufficient to recover the net carrying amount of the long-lived and finite life intangible assets supporting the Saab asset group.  Subsequent to year-end, these lease agreements were rejected by the Company following our Bankruptcy Filing and the aircraft have been returned to their owners.

As a result, during the three months ended December 31, 2011, we increased the Saab-related excess equipment reserve by $3.7 million, recorded an exit liability of $3.2 million for the seven leased Saab aircraft, and recorded an impairment charge of $7.8 million against the long-lived and finite life intangible assets supporting the Saab asset group.  The impairment charge was allocated on a pro-rata basis to flight equipment and intangible assets for $6.5 million and $1.3 million, respectively.

2009 – During 2009, we recorded a net increase to operating expense related to $2.0 million of return costs associated with the retirement of our Beech 1900 aircraft fleet.

Restructuring Expenses

2011 – On December 8, 2011, we announced that we had commenced a comprehensive program to reduce short-term and long-term costs and enhance liquidity, seeking modifications to our agreements with various stakeholders (the “Restructuring”).  In connection with the Restructuring, we engaged consultants, investment banks, and external counsel and performed an analysis of our partner contract profitability and examined alternatives to rationalize our business lines, organizational structure, and executive and director level functions.  During 2011, we incurred $1.9 million in expenses associated with the Restructuring.

2011 Compared to 2010

Operating Revenues

Operating revenue of $1.232 billion for 2011 increased $211.6 million, or 21%, compared to 2010.  The increase in operating revenues was mainly attributable to the increase in our Q400 fleet size and the year-over-year increase in the rates earned under our operating contracts. The acquisition of Mesaba, which occurred on July 1, 2010, contributed additional revenue of approximately $136 million in 2011 as compared to 2010. These changes are discussed in greater detail within our segmented results of operations.

 
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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
Our operating contracts fall under two categories: capacity purchase agreements ("CPA") and revenue pro-rate agreements. Changes in our CPA related operating revenue are primarily caused by changes in our operating fleet size, our aircraft utilization, rates earned under our operating contracts, and costs that are directly reimbursed by our partners. 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 EAS agreements.

Operating Expenses

Operating expense of $1.231 billion increased by $272.0 million, or 28%, as compared to 2010. The change in consolidated operating expense is primarily attributable to:

·  
special items of $28.5 million, consisting of integration, impairment, and restructuring charges, as previously discussed.
·  
significant increases in pilot labor and related costs compared to the prior year levels due to the ALPA JCBA, and the implementation of the ISL and the Bloch Ruling;
·  
increases in crew-related expenses, including premium pay, hiring, training, and crew overnight accommodations, as a result of the distribution of our crews across the network due to partner schedule changes and the expenses associated with staging impacted crews at various destinations, decreasing consolidated operating income by approximately $21 million during 2011 as compared to 2010;
·  
increases in maintenance expense due to the aging of our fleet;
·  
increases in fuel expenses incurred under our Pro-Rate operations at Colgan of $4.9 million due to an increase of 23% in the price per gallon of aircraft fuel, partially offset by a decrease in gallons consumed, during 2011 as compared to 2010.

Nonoperating expense

Net nonoperating expense of $47.2 million for 2011 increased by approximately $6.6 million, or 16%, as compared to 2010.  The increase was primarily attributable to increased interest expense of $10.3 million, related to increased borrowings on our 16 Q400 aircraft that delivered throughout the second half of 2010 and the first half or 2011, and increased borrowings under the Spare Parts Loan.  Offsetting this increase were increases in miscellaneous income, primarily related to realized gains recorded on our ARS Call Options, and decreases in losses on our interest rate “swaptions.”

Income tax expense

We recorded an income tax benefit of $14.6 million for 2011, as compared to income tax expense of $8.1 million in 2010.  This change is primarily a result of the Company’s incurring a loss before income taxes in 2011 as compared to income before income taxes in 2010.
 
2010 Compared to 2009

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.)

 
33

 
Item 7.  Management’s Discussion and Analysis of Financial Condition and 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 note payable to Delta for the purchase of Mesaba, 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.”   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 our Senior Convertible 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. 

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 Internal Revenue Service (“the Service”) 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.  We 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 13, Income Taxes, in Item 8 of this Form 10-K for more discussion.  


The following represents our results of operations by segment, for the year ended December 31, 2011.  A discussion of our results of operations as compared to 2010 and 2009 follows.

 
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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Pinnacle Operating Highlights
 
   
Years Ended December 31,
 
   
2011
   
% Change
2011 - 2010
   
2010
   
% Change
2010 - 2009
   
2009
 
Financial Results (in thousands)
                             
Total operating revenues
  $ 645,409       2 %   $ 634,461       4 %     609,246  
Total operating expenses
    634,235       8 %     589,115       7 %     552,777  
Operating income
    11,174       (75 ) %     45,346       (20 )%     56,469  
Operating margin
    1.7 %             7.1 %             9.3 %
                                         
Operating Results
                                       
Operating revenue per block hour
  $ 1,557       5 %   $ 1,488       4 %   $ 1,429  
Operating cost per block hour
  $ 1,530       11 %   $ 1,382       7 %   $ 1,296  
Block hours
    414,496       (3 )%     426,285       (0 )%     426,432  
Departures
    264,906       (4 )%     274,850       1 %     273,077  
Average daily utilization (block hours)
    8.10       (1 )%     8.22       (0 )%     8.26  
Average stage length (miles)
    418       (0 )%     419       (2 )%     426  
Number of operating aircraft (end of period):
                                       
    CRJ-200
    122       (3 )%     126       0 %     126  
    CRJ-900
    16       0 %     16       0 %     16  
 
Pinnacle Operating Revenues

2011 Compared to 2010

Operating revenues for 2011 of $645.4 million increased by $10.9 million, or 2%, as compared to 2010.  During 2011, revenue increased by approximately $14.2 million as a result of the annual rate adjustment in our CPAs with Delta, which was partially offset by a $4.4 million decrease in volume-based revenue.  This increase was also partially offset by additional performance and other penalties incurred of $1.7 million. Additionally, due to a dispute with Delta over certain reimbursable heavy maintenance costs, we recorded a reduction in revenue of $4.5 million. Due to a change in the mix of cities we serve, revenue also increased by $4.0 million during the same period. The remaining $3.3 million increase is primarily related to increases in certain reimbursable expenses.

2010 Compared to 2009

For the year ended December 31, 2010, operating revenues of $634.5 million increased by $25.2 million, or 4%, as compared to 2009.  In 2010, the rates that Delta paid us under our CPAs increased by 4%, causing revenue to increase by approximately $13.1 million.  Additionally, a change in reimbursable expenses caused revenue to increase by $13.2 million for the year ended December 31, 2010.  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.  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.

Pinnacle Operating Expenses

2011 Compared to 2010

During 2011, operating expenses increased by $45.1 million, or 8%, as compared to 2010.  This increase is primarily the result of the February 2011 ratification of the new collective bargaining agreement with ALPA and the related implementation of the new ISL and the Bloch Ruling, along with costs incurred as a result of the delay in our integration plan.


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


Crew-related expenses, including premium pay, hiring, training, and crew overnight accommodations, also increased during 2011 as compared to 2010, as a result of the distribution of our crews across the network due to Delta schedule changes and expenses associated with staging those crews at various destinations.  During 2011, Pinnacle also experienced an increase in reimbursable expenses, which primarily consisted of increased maintenance expenses, related to the aging of the fleet, offset by decreases in certain deicing services, insurance premiums expense, and property tax expense.

2010 Compared to 2009

Operating expenses for 2010 of $589.1 million increased by $36.3 million, or 7%, as compared to 2009.  Increases in salaries, wages and benefits increased $18.2 million, or 11%, in 2010 as compared to 2009, primarily attributable to the $10.9 million charge in the fourth quarter of 2010 for pilot bonuses, as well as headcount and wage increases.  Aircraft maintenance, materials and repairs expenses increased $8.2 million, or 14%, primarily related to increased reimbursable costs for heavy airframe maintenance on our fleet of CRJ-200 aircraft. Other increased expenses included property tax expense, which was due to a one-time reduction of property tax expense in 2009 from a settlement with the state of Tennessee, insurance expense related to Pinnacle’s new insurance coverage, and increased costs related to flight crew training and other crew related expenses.

Mesaba Operating Highlights

   
Periods Ended December 31,
 
   
2011
   
% Change 2011 - 2010
   
2010(1)
 
Financial Results (in thousands)
                 
     Regional airline services
                 
        CPAs
    252,829       79 %     141,178  
        Pro-Rate
    25,140       100 %     -  
        Other
    -       (100 ) %     1,210  
Total operating revenues
    277,969       95 %     142,388  
Total operating expenses
    277,177       104 %     135,541  
Operating (loss) income
    792       (88 )%     6,847  
Operating margin
    0.3 %             4.8 %
                         
Operating Results
                       
Operating revenue per block hour
    1,211       11 %   $ 1,087  
Operating cost per block hour
    1,208       17 %   $ 1,035  
Block hours
    229,528       75 %     131,017  
Departures
    136,451       70 %     80,173  
Average daily utilization (block hours)
    7.67       (2 )%     7.84  
Average stage length (miles)
    527       (1 )%     534  
Number of operating aircraft (end of period):
                       
    CRJ-900
    41       0 %     41  
    CRJ-200
    19       0 %     19  
    Saab 340 B+
    -       (100 )%     26  

(1)
As previously discussed, the acquisition of Mesaba was completed on July 1, 2010. As such, Mesaba’s 2009 results of operations are not presented.  Mesaba’s 2010 results of operations include the period from the acquisition date through December 31, 2010.

Mesaba Operating Revenues

Mesaba’s CPA related operating revenue for the full year 2011 of $252.8 million increased by $111.7 million, or 79%, as compared to the six-month period from the date of the acquisition through the end of 2010. This increase is related to the additional periods presented, offset by a decrease in revenue related to the wind-down of Mesaba’s Saab operation. As previously discussed, Mesaba ceased operating Saabs for Delta during the fourth quarter of 2011. As a result, the average number of Saabs operating under the CPA decreased 57% during 2011 as compared to 2010. Offsetting this decrease, Mesaba earned $25.1 million in revenue related to its Pro-Rate operations during 2011. The Pro-Rate operations, which begin in March 2011, ended in December 2011.

 
36

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

During 2011, Mesaba’s operating expenses increased by $141.6 million, or 104%, as compared to the six- month period from the date of the acquisition through the end of 2010.  Mesaba’s results were adversely affected by the ALPA collective bargaining agreement and the implementation of the ISL and the Bloch Ruling, which increased regional jet pilot-related expenses during 2011 as compared to 2010.  In addition, Mesaba incurred start-up expenses related to the new Pro-Rate operations, experienced low crew utilization, and incurred $6.4 million in fuel costs.  These increases were offset by decreases in certain operating expenses related to the wind-down of the Saab operations.

Colgan Operating Highlights

   
Years Ended December 31,
 
   
2011
   
% Change
2011 - 2010
   
2010
   
% Change
2010 - 2009
   
2009
 
Financial Results (in thousands)
                             
     Regional airline services
                             
        Pro-Rate and EAS
    151,134       (1 )%     153,409       (0 )%     154,026  
        CPA
    138,109       78 %     77,401       6 %     73,125  
     Other revenue
    33,089       39 %     23,883       162 %     9,111  
Total operating revenues
    322,332       27 %     254,693       8 %     236,262  
Total operating expenses
    304,648       24 %     245,353       16 %     212,022  
Operating income
    17,684       89 %     9,340       (61 )%     24,240  
Operating margin
    5.5 %             3.7 %             10.3 %
                                         
Operating Results
                                       
Pro-Rate and EAS Agreements:
                                       
Revenue passengers (in thousands)
    1,054       (9 )%     1,157       (1 )%     1,169  
RPMs (in thousands)
    179,307       (10 )%     199,852       (2 )%     203,848  
ASMs (in thousands)
    364,498       (12 )%     415,391       (9 )%     456,664  
Passenger load factor
    49.2 %  
1.1 pts.
      48.1 %  
3.5 pts.
      44.6 %
Passenger yield (in cents)
    84.29       10 %     76.76       2 %     75.56  
Operating revenue per ASM (in cents)
    41.46       12 %     36.93       9 %     33.73  
Fuel consumption (in thousands of gallons)
    9,041       (4 )%     9,416       (14 )%     10,994  
Average price per gallon
    3.39       23 %     2.76       37 %   $ 2.01  
Average fare
  $ 143       8 %   $ 133       1 %   $ 132  

Capacity Purchase Agreements:
                             
Revenue passengers (in thousands)
    2,851       81 %     1,575       3 %     1,533  
RPMs (in thousands)
    897,197       84 %     488,892       12 %     437,221  
ASMs (in thousands)
    1,314,934       86 %     705,767       10 %     638,821  
Passenger load factor
    68.2 %  
(1.1) pts.
      69.3 %  
0.9 pts.
      68.4 %
Operating revenue per block hour
  $ 1,606       1 %   $ 1,589       2 %   $ 1,551  
Block hours
    85,983       77 %     48,697       3 %     47,143  
Departures
    57,270       80 %     31,733       3 %     30,702  

Total Colgan:
                             
Average daily utilization (block hours)
    7.45       0 %     7.45       (5 )%     7.84  
Average stage length (miles)
    261       12 %     233       4 %     223  
Operating cost per ASM (in cents)
    18.14       (17 )%     21.88       13 %     19.35  
Operating cost per block hour
  $ 1,882       1 %   $ 1,857       21 %   $ 1,535  
ASMs (in thousands)
    1,679,432       50 %     1,121,158       2 %     1,095,485  
Block hours
    161,871       23 %     132,137       (4 )%     138,166  
Departures
    123,399       17 %     105,865       (4 )%     110,568  
Number of operating aircraft (end of period)
                                       
     Saab 340
    32       (3 )%     33       (3 )%     34  
     Q400
    31       41 %     22       57 %     14  
 
 
 
37

 
Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations>
 
 
Colgan Operating Revenue
 
2011 Compared to 2010

Revenue earned under our Pro-Rate and EAS agreements decreased by $2.3 million, or 1%, during 2011 as compared to 2010. The decrease is primarily related to a reduction of 12% in available seat miles during 2011, which is due to a reduction in the scope of our Pro-Rate operations. This decrease is offset by an average fare increase of 8% during 2011 as compared to 2010, as well as a slight increase in load factor.

Revenue earned under our Q400 CPA for 2011 increased $60.7 million, or 78%, as compared to 2010, primarily due to increases in our fleet size. The average number of Q400 aircraft in Colgan’s fleet for 2011 increased by 82% as compared to 2010.

Other revenue, which primarily consists of revenue earned by PinnPro for performing ground handling services for other airlines, increased by $9.2 million, or 39%, for 2011 as compared to the prior year. The increase in revenue is mainly attributable to PinnPro performing third party ground handling services at several additional airports.

2010 Compared to 2009

Total operating revenue for the year ended December 31, 2010 of $254.7 million increased by $18.4 million, or 8%, from the same period in 2009.  The primary reason for this increase is the increase in revenue earned under our Q400 CPA offset by a decrease in our pro-rate operations.

Revenue under our Q400 CPA for the year ended December 31, 2010 increased by $4.3 million, or 6%, due to changes in rates, volume and changes in pass-through costs.  The average number of Q400 aircraft in Colgan’s fleet for the year ended December 31, 2010 increased by 6% as compared to the same period in 2009.  During the year ended December 31, 2010, we added eight additional Q400 aircraft.

Revenue earned under our pro-rate agreements decreased by $2.2 million during the year ended December 31, 2010.  The decrease in revenue is attributable to the 1% decrease in passengers carried, which resulted in a $3.3 million decrease in revenue.  This decrease in revenue related to passengers carried is offset by the 1% increase in the average fare which resulted in a $1.1 million increase in revenue under our pro-rate agreements.

Revenue earned under our EAS agreements increased by $1.6 million during the year ended December 31, 2010, primarily due to a 9% increase in our rates and the addition of new markets.  The increase in our rates related to our EAS agreements increased revenue by $1.3 million and the addition of the new markets increased revenue by $0.3 million.  

Colgan Operating Expenses

2011 Compared to 2010

During 2011, operating expenses increased $59.3 million, or 24%, as compared to 2010. The increase is primarily attributable to the growth of our operating fleet of Q400 aircraft, which caused increases in salaries, wages and benefits, depreciation expense, landing fees, crew training expense, and crew overnight accommodations expense. Aircraft fuel expense increased $4.9 million for 2011 as compared to 2010. The increase is related to the increase in the average price of fuel, which is partially offset by a decrease of 4% in the number of gallons consumed for 2011 as compared to 2010.  Maintenance expense increased as our fleet continues to age.  In addition, we incurred certain one-time costs associated with the initiation of Q400 service at Washington Dulles International Airport and George Bush/Houston Intercontinental Airport.  Lastly, Colgan’s operating expenses also increased due to the new collective bargaining agreement with ALPA and the implementation of the ISL and the Bloch Ruling.

 
38

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

 
2010 Compared to 2009

During 2010, operating expenses increased $33.3 million, or 16%, as compared to 2009.   The increase is primarily attributable to additional salaries, wages, and benefits, recruiting, flight crew training and other crew related expenses due to the deliveries of additional Q400 aircraft during 2010 and early 2011. Aircraft fuel expense increased $3.9 million, primarily related to the 37% increase in the average price of fuel, offset by a 14% decrease in the total number of gallons consumed during 2010.  In addition, aircraft maintenance, materials and repairs expenses increased $7.7 million due to an increase in engine maintenance expense related to a new maintenance contract covering our Q400 engines.  Insurance coverage obtained in July 2009 with significantly higher rates resulted in increases in aircraft and passenger liability related insurance year over year.  Lastly, we incurred $2.0 million fleet retirement charges related to certain maintenance costs necessary to restore certain Saab and Beech aircraft to a condition suitable for return to the lessor or for sale.


We generate cash primarily by providing regional airline and related services to our code-share partners and passengers.  As of December 31, 2011, we had cash and cash equivalents of $66.3 million.  Net cash provided by operations was $41.8 million for the year ended December 31, 2011.  At this time, we do not anticipate making federal income tax payments in 2012 due to the accelerated depreciation recognized for tax purposes related to our CRJ-900 and Q400 aircraft.

We acquired eight Q400 aircraft during 2011 and completed the related financings at a weighted average interest rate of 4.9%. 

In June 2011, we completed a sale-leaseback transaction with Siemens Financial Services, Inc. that resulted in the sale of two Q400 aircraft, which had been acquired by the Company in 2011.  The proceeds of the sale were used to settle long-term debt and accrued interest of $35.8 million and resulted in net cash proceeds of $5.8 million.  The net cash proceeds were used to increase working capital.

During June 2011, we also modified our loan financing agreement with C.I.T. Leasing and funded by CIT Bank (the “Spare Parts Loan”).  We increased our financing under the Spare Parts Loan to $37.0 million, which resulted in net cash proceeds of $13.4 million, and we extended the maturity date through December 2015.  A portion of the Spare Parts Loan is subject to a fixed interest rate of 7.25%.  The remainder of the Spare Parts Loan is subject to a variable interest rate, which is indexed to LIBOR and was 5.5% as of December 31, 2011.  The Spare Parts Loan is secured by spare repairable, rotable and expendable parts and certain aircraft engines at all three airlines.  The net cash proceeds were used to increase working capital.

In May 2012, we amended and restated the Spare Parts Loan to allow us to sell an unlimited amount of consumable/expendable spare parts, rotable spare parts and spare engines relating to certain aircraft without the consent of C.I.T. Leasing, so long as the net sales proceeds from the sale of any item of collateral are used to repay the Spare Parts Loan.  In connection with the amendment and restatement, C.I.T. Leasing agreed to waive any terms of the Spare Parts Loan under which an event of default would result from a loss of Mesaba’s operating certificate.  C.I.T. Leasing also agreed that we need not comply with certain financial reporting requirements during the pendency of our Chapter 11 proceedings, to suspend application of certain restrictive covenants during the Chapter 11 proceedings, to waive accrual of interest at the default rate during the Chapter 11 proceedings and to permit a merger or certain other “fundamental changes” in connection with our emergence from Chapter 11 if certain conditions are met.  The interest rate was fixed at 8.50%, the maturity date was adjusted from December 31, 2015 to June 30, 2014 and C.I.T. Leasing received a fee of $100,000.  On May 11, 2012, the Bankruptcy Court entered a final order approving, and authorizing us to enter into and perform under, the amended and restated loan financing agreement [ECF No. 277].

 
39

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

On January 26, 2012, Pinnacle Airlines Corp. and Colgan signed a Forbearance Agreement with EDC, in which EDC allowed us to defer certain principal and interest payments due to them as of January 14, 2012 through March 31, 2012.  This agreement provided that we are not in default under our various loan agreements during the forbearance period, but that on April 2, 2012 the amounts deferred would become due and payable.  This agreement provided us with $16.6 million in liquidity assistance in the form of deferred payments.  Subsequent to this transaction, we entered into the interim agreement, amending the United Q400 CPA, which directed United to pay the EDC directly for ownership expense associated with the Q400 aircraft during the deferral period.  This change eliminated the benefit of the deferral for the Company, but that lost benefit was more than offset by the increase in revenue associated with the revised rates in the CPA amendment.

In addition, we were notified by Delta that they would not be reimbursing us for our ownership expense incurred on the CRJ-900 fleet owned by Pinnacle during the deferral period.  Pinnacle disagreed with Delta’s position, but elected to pay EDC the deferred principal and interest due so that we could receive our reimbursement from Delta.  Therefore, the benefit to short term liquidity of the EDC Forbearance agreement with respect to the CRJ-900s was completely voided.

The Final Order entered by the Bankruptcy Court in connection with the United Agreement on April 23, 2012 also authorized the Company to perform its obligations under the EDC Agreement among the Company, EDC and United.  The material terms of the EDC Agreement include:

·  
As of the Petition Date, Colgan shall be deemed to have returned to EDC all Q400 Covered Equipment used to perform the regional air services under the United Agreement.
·  
EDC waived its right to seek administrative expense claims against the Companies in connection with such return but reserved its right to seek administrative expense claims against the Companies in connection with any breach of the EDC Agreement itself.
·  
Colgan shall be entitled to use such Q400 Covered Equipment in connection with its provision of regional air services under the United Agreement.
·  
Upon the wind-down of any such Q400 Covered Equipment under the United Agreement, Colgan is required to physically return such Q400 Covered Equipment to EDC. Upon such return, EDC is authorized to dispose of such Q400 Covered Equipment without the consent of the Companies.

Beginning in late 2011 and continuing during the Company’s Chapter 11 cases, we have been engaged in a restructuring campaign aimed at improving the profitability of some of our operating contracts, renegotiating some onerous provisions in our collective bargaining agreements, and improving our overall liquidity position.  Without successful renegotiations with our aircraft counterparties and revised collective bargaining agreements, we anticipate that our liquidity position will continue to worsen and that the prospects for relief from any of our current partners, capital providers and lenders will be difficult to achieve.

Operating activities – Net cash provided by operating activities was $41.8 million during the year ended December 31, 2011.  The decrease between 2011 and 2010 is primarily attributable to the approximately $38 million tax refund we received in February 2010 and the decrease in net income between periods.

Net cash provided by operating activities was $109.4 million during the year ended December 31, 2010.  This is primarily attributable to tax refunds of approximately $42 million received in 2010, and due to $67.4 million in cash generated from our operations.  As mentioned previously, Mesaba generated approximately $23 million in operating cash flow for the year ended December 31, 2010.  Net cash provided by operating activities was $105.6 million during the year ended December 31, 2009.  This is primarily attributable to the approximately $33 million tax refund we received in April 2009, and due to approximately $73 million in cash generated from our operations.

Investing activities Net cash used in investing activities was $8.5 million during the year ended December 31, 2011.  While cash purchases of property and equipment increased $5.9 million between periods, such increase was offset by cash inflows from the sale-leaseback of two Q400 aircraft, which generated net cash proceeds of $5.8 million, and an increase of $4.7 million in cash proceeds from redemptions on our ARS call options.

We do not expect to have material cash capital expenditures for 2012.  We expect to fund any capital expenditures with existing cash resources and cash flows generated from our operations.


 
40

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


Net cash used in investing activities for the year ended December 31, 2010 was $13.5 million.  This is primarily attributable to $9.9 million in purchases of property and equipment, $5.3 million paid in pre-delivery payments for Q400 aircraft deliveries, and $2.4 million for the acquisition of Mesaba, partially offset by $4.1 million of cash proceeds from the sale of property and equipment and investments.

Net cash provided by investing activities for the year ended December 31, 2009 was $24.2 million.  This was primarily attributable to proceeds received from certain ARS redemptions at par by the issuers, proceeds from sale of our ARS portfolio, and net proceeds from exercises of a portion of the ARS call options, totaling $29.1 million.  In addition, we received net insurance proceeds of $3.6 million.  These amounts were offset by $8.4 million in cash purchases of property and equipment.
 
Financing activities – Net cash used in financing activities was $67.1 million for the year ended December 31, 2011.  This was related to $19.3 million for payments on our pre-delivery payment facility, $58.6 million of principal payments on debt obligations, and $2.7 million related to other financing activities.  These related debt payments are partially offset by $13.4 million in net cash proceeds related to the modification of the Spare Parts Loan.

Net cash used in financing activities for the year ended December 31, 2010 totaled $87.4 million.  This was primarily related to $31.0 million used to repurchase the remaining par amount of our Notes, $65.6 million of principal payments on other debt obligations, including the $10.0 million Bridge Loan, $1.7 million related to payments on capital leases, and $1.2 million related to other financing activities, including $0.3 million in treasury share repurchases associated with management compensation incentive plans.  We received the $10.0 million proceeds of the Bridge Loan in January 2010, and repaid the Bridge Loan in full upon receipt of our federal income tax refund in February 2010.

Debtor-in-Possession Financing.  In connection with the Company’s Chapter 11 cases, on May 18, 2012, the Company and Delta entered into a debtor-in-possession credit agreement pursuant to which Delta agreed to provide $74,285,000 in secured debtor-in-possession financing (the “DIP Financing”) to Pinnacle Airlines Corp., guaranteed by Pinnacle Airlines Corp.’s subsidiaries.  Such DIP Financing was approved by final order of the Bankruptcy Court on May 17, 2012 [ECF No. 316].

The DIP Financing has a term of one year from the date of the filing of the Company’s Chapter 11 cases (subject to early termination in certain instances) and accrues interest at the rate of 12.5% per annum.  There is no additional fee payable to Delta in connection with the DIP Financing.  The DIP Financing contains customary default provisions, and certain milestones that must be met relating to the delivery of a six-year business plan, filing and confirmation of a plan of reorganization and modifications to collective bargaining agreements through a settlement or relief under Section 1113 of the Bankruptcy Code.  Approximately $46.2 million of the DIP Financing was used to repay Delta’s existing secured promissory note and the balance of the DIP Financing is additional available working capital for the Company.  If certain conditions are satisfied, including substantial consummation of a plan of reorganization that is reasonably acceptable to Delta and the absence of a continuing or unwaived default or event of default, Delta has agreed to convert the DIP Financing into a senior secured exit financing facility.

The Bankruptcy Filing is intended to permit the Company to reorganize and improve liquidity, reduce costs, wind down unprofitable contracts and focus on the most valuable business lines to enable sustainable profitability.  The Company’s goal is to develop and implement a reorganizatio