FORM 10K for Pinnacle Airlines 12-Mar 2009
Summary of PINNACLE AIRLINES CORP - Yahoo! Finance
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12-Mar-2009
Annual Report
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview and Outlook
General
During 2008, we further executed on our growth plan by adding 15 Q400 aircraft at our Colgan subsidiary and 13 CRJ-900 aircraft at our Pinnacle subsidiary, with two additional CRJ-900 aircraft scheduled to deliver in the second quarter of 2009. With this phase of our growth plan essentially complete, we intend to focus on controlling costs, maintaining our strong operational reliability, and strengthening our balance sheet. The regional airline industry is facing a period of slower growth and pressure from major airline partners to reduce costs and potentially reduce some regional airline capacity. While we do not expect significant adjustments in our fleet size in 2009, we do expect to experience significant cost pressure during this period of low growth. Specifically, we anticipate higher costs in 2009 resulting from an expected new collective bargaining agreement with our pilots at Pinnacle, higher levels of flight crew staffing at Pinnacle, higher health care costs, increased landing fees and facility rental expense at the airports that we serve, and general inflationary pressure within the rest of our cost structure.
In addition, our pro-rate operations are susceptible to fuel price volatility and changes in passenger demand. During the first half of 2008, we experienced an unprecedented increase in the price of fuel within our pro-rate operations, and as a result, Colgan incurred an operating loss of $7.9 million during 2008 (which includes $13.5 million of non-recurring charges related to goodwill impairment and lease return costs). In response, we implemented a turn-around plan during the second half of 2008 to improve the results of our pro-rate operations. Key components of the plan included eliminating our Beech 1900 fleet, reducing our Saab 340 fleet by six aircraft, eliminating our worst performing markets, rebidding markets that we serve under the federal government's Essential Air Service program ("EAS") to increase the subsidies we receive, and renegotiating a connect incentive fee that we receive from United for certain markets that we serve as a United Express carrier. While these steps and the recent decline in fuel prices have reduced the operating losses of our pro-rate operations, our pro-rate operations are not yet profitable. Additionally, the airline industry is beginning to experience the effects of the current recessionary environment in the United States. Industry revenue and demand dropped during the fourth quarter of 2008, and we are beginning to see trends of lower unit revenue within our pro-rate operations. We cannot predict how severely the recessionary environment will affect us in 2009, but we do expect a significant drop in our unit revenue within our pro-rate operations.
Further magnifying the cost pressures previously discussed, we will not receive an increase in the rates Delta pays us under our CRJ-200 ASA. The CRJ-200 ASA contains a provision to adjust rates annually based on the change in the Producers Price Index ("PPI"), as published by the United States Department of Labor, Bureau of Labor Statistics. Our rates could increase by up to 5% annually, but in no case would they decrease. The PPI declined from December 2007 to December 2008, and as a result, our rates will not increase in 2009.
To offset some of the increased costs and pro-rate operations risk that we expect to incur in 2009, we recently announced an internal initiative to create costs savings and additional revenue opportunities of at least $10.0 million. We expect to achieve this through a combination of reducing our operating costs, adjusting capacity in our pro-rate operations to match the demand environment, identifying new pro-rate markets with stronger revenue prospects, potentially reducing the scope of our pro-rate operations by retiring additional Saab aircraft as necessary, and increasing ancillary third party business such as ground handling. We have not yet fully identified these initiatives, and there can be no assurance that we will attain our target of at least $10.0 million in improvements. We believe it is critical to reduce our costs not only to increase our current profitability, but to also remain competitive long term in the regional airline industry.
The collective bargaining agreement between Pinnacle and the Air Line Pilots Association ("ALPA"), the union representing Pinnacle's pilots, has been amendable since April 2005. We have met with ALPA, both with and without a mediator, many times since April 2005, but we have not reached an agreement for a new contract. It is of utmost importance to us to reach an agreement with ALPA that is consistent with our company-wide philosophy of industry-average pay and benefits with enhanced employee productivity. Wage rates for Pinnacle's pilot group are currently below industry average, and a new collective bargaining agreement is expected to contain an increase in pay for Pinnacle's pilots. Such increase could be substantial, and may also include a considerable one-time signing bonus. The increase in pay for Pinnacle's pilots will likely reduce our profitability in 2009 and in future periods.
In addition, Colgan's pilots recently elected representation by ALPA. We have not begun discussions or set a timeline with ALPA to commence negotiations of a collective bargaining agreement covering Colgan's pilots. While we intend to vigorously pursue obtaining a fair contract with ALPA at both of our operating subsidiaries, the timing of the resolution of these matters cannot be predicted.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
While we expect 2009 to be a challenging year, we are positioning ourselves for success in 2010 and beyond. We recently agreed with Continental to expand our Continental CPA by adding 15 Q400 aircraft from August 2010 through April 2011. In addition, we acquired an additional 15 Q400 options from the aircraft manufacturer, thereby increasing the total number of our Q400 options to
30. These options, if exercised, provide for the delivery of 15 Q400s in 2011 and the remaining 15 in 2013. The Q400 aircraft has become a very competitive product within the regional airline industry. The purchase price of the Q400 is significantly less than that of comparably sized regional jets, and the Q400 uses up to 30% less fuel. As a result, we can offer our airline partners a large, passenger-friendly regional aircraft with a lower operating cost than similar regional jets. Several of our partners have indicated interest in the Q400 aircraft, and we continue to market our option positions to them.
In addition to growing Colgan with the Q400 aircraft, we expect to find other long-term opportunities to increase the number of regional jets that we operate at Pinnacle. Capacity purchase agreements for over 400 50-seat regional jet aircraft at our competitors are set to expire between 2009 and 2015. While many of these regional jets will likely no longer operate within the networks of the major U.S. airlines, we believe some of these contracts will be renewed or offered to other regional airlines and some will be replaced with larger regional jets. We intend to actively compete to obtain profitable regional jet flying during this period of transition within the industry, and we believe our history of quality performance at a competitive price well positions us to succeed. Our capacity purchase contracts do not begin to expire until December 2017.
Auction Rate Securities
We continue to own approximately $133.7 million par amount of auction rate securities ("ARS"). Due to unprecedented events in the credit markets during 2008, these investments became illiquid and have suffered a decline in fair value. We reported these investments as noncurrent assets on our consolidated balance sheet at December 31, 2008 at their estimated fair value of $116.9 million. We continue to earn interest on all of our ARS, and the majority of our ARS are still rated AAA/Aaa by the credit rating agencies. Most of the banks that structured and sold ARS to investors have entered into settlement agreements with various state and federal regulatory authorities that provide for the repurchase of ARS at par value from retail investors and small businesses over the next 24 months. In addition, some banks have made offers to larger institutional investors to repurchase ARS at par value in 2009 and 2010 to the extent that institutional investors have been unable to sell their ARS. We have not yet received such an offer from the financial institution that structured and sold to us our ARS, and we have no assurance that we will receive such an offer. However, we anticipate that to the extent most major banks make settlement offers to their institutional clients, we would be made a similar offer for settlement related to our ARS holdings.
The collapse of the ARS market has had a significantly negative impact on our liquidity and the strength of our balance sheet. To partially offset this effect, we arranged for a $90.0 million margin loan facility (the "Credit Facility") to be used to support our aircraft purchases and other working capital requirements. Although the Credit Facility has a maturity date in January 2010, we anticipate that the Credit Facility will remain outstanding until we receive an offer to repurchase our ARS or otherwise monetize our ARS portfolio. While we have effectively obtained the use of $90.0 million of our ARS through this Credit Facility, we do not have access to the remaining $43.7 million par amount of our ARS to support our liquidity needs. We do not know when we will be able to monetize our ARS portfolio, and we may have no choice but to sell our ARS at current distressed prices or to hold our securities until maturity, which could be 17 years or longer.
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)
$121 Million Senior Convertible Notes
In addition to actions noted above to improve our operating income longer term, we are focused on conserving cash in 2009 in advance of the first date that holders of our $121.0 million 3.25% senior convertible notes (the "Notes") may contractually require us to repay the Notes. Although the Notes have a final maturity date in 2025, holders of the Notes may tender them to us on February 15, 2010 for a cash payment equal to the par amount. While we anticipate positive cash flow from our operations during 2009, we do not believe that we will have sufficient cash resources to fully repay this obligation in February 2010 without raising additional capital. We are focused on obtaining the resources we need to settle this obligation without raising capital through a shareholder dilutive action such as an offering of our common stock. Some alternatives we are reviewing include asset financings, such as the financing of our rotable and expendable spare parts inventory, raising additional capital collateralized by ARS, or the sale of some or all of our ARS.
We repurchased $12.0 million par amount of the Notes for approximately $8.9 million in January 2009. The Notes are relatively illiquid, but the few recent trades we have observed have been at prices substantially below par. We may purchase additional Notes during 2009 to the extent that Notes are offered for sale and to the extent that our resources allow.
Colgan Flight 3407 On February 12, 2009, Colgan Flight 3407, operated for Continental under the Company's Continental CPA, crashed in a neighborhood near the Buffalo Niagara International Airport in Buffalo, New York. All 49 people aboard, including 45 passengers and four members of the flight crew, died in the accident. Additionally, one individual died inside the home destroyed by the aircraft's impact, increasing the total fatality count to 50 individuals. One lawsuit related to this accident has been filed against the Company, and additional litigation is anticipated. We carry aviation risk liability insurance and believe that this insurance is sufficient to cover any liability arising from this accident.