This year will be a tough, but promising, transition year for Pinnacle Airlines Corp. (PNCL) as it moves from a single-customer airline into serving two or more carriers and imposes changes on its newly acquired subsidiary, Colgan. However, its new hub operation for Continental (CAL) at Newark and restructuring its Northwest Airlink program, is being hampered by the loss of pilots to mainline carriers which compromised its performance for which it expects to incur penalties between $1.2 million and $1.3 million.
Anticipation of its new contract with Northwest (NWACQ) prompted premature hiring of pilots impacting its fourth quarter results. It also took on the ground handling for 13 new Northwest points, the last of which was taken over in January, which resulted in a 12 percent decrease in operating income and the decrease of 0.8 points in operating margin but promises to pay off in the long term, according to President and CEO Phil Trenary, who briefed investors last week With the sale of its Northwest claim in January, it was able to end that month with $375 million in cash and short-term investments.
“We had too many pilots in Q4,” said Trenary, “and then experienced attrition so we didn’t have enough pilots in Q1. It is an issue of being short 35 captains. We can produce 24 captains a month but we hope to accelerate that with the enhancements we are making in our training process.” The airline has three full simulators and new-generation training devices which will result in increasing the rate to 30 pilots a month.
Pinnacle does not anticipate Colgan, which, in 2006, earned $2 million to $2.5 million, to have any impact on revenues this year, largely owing to the changes planned there. However, it pointed out the smaller carrier was in the middle of its year-end audit. Pinnacle expects to change systems to better practices and increase efficiency. Part of the plan is to convert the airline to FAA’s Air Transportation Oversight System (ATOS), something that has had positive results at Pinnacle.
The deal with Continental is a pro-rate agreement with operational and connection incentives built in. The highly-seasonal turboprop carrier’s normal revenue stream incurs losses in Q1 and Q4 and income in Q2 and Q3. “We did not buy Colgan just to run Q400s alone,” said Trenary, who said he is still in negotiations with Bombardier (BBD) for the aircraft. “We believe other carriers, besides Continental, will fall in love with the Q400 and we expect to find customers to operate larger regional jets. Pinnacle is the platform for operating 50- and 76-seat CRJs, and Colgan will operate the Q-400s and Saabs and we plan to add customers as well as more return customers to both Pinnacle and Colgan.”

Net income during the fourth quarter of 2006 was positively impacted by an after-tax benefit of $26.1 million, or $1.18 per share, associated with the settlement with Northwest and the related revaluation of the Company's reserve for items owed by Northwest. Net income was also affected by a $1.5 million charge, or $0.07 per share, to increase the Company's reserve related to uncertain tax positions. Excluding these two items, Pinnacle's net income and EPS for the fourth quarter 2006 would have been $12.3 million and $0.56, respectively. Net income and EPS for the fourth quarter 2005 was $13.2 million and $0.60, excluding charges related to the bankruptcy filings of Northwest and Mesaba.
"With the sale of our Northwest claim, the acquisition of Colgan Air, and the expansion of Colgan's relationship with Continental Airlines, we now have a strong balance sheet and revenue diversification to match our industry-leading operating performance," said Peter Hunt, Pinnacle's Chief Financial Officer. "We believe these investments provide the prospects for long-term profitable growth for our shareholders."
For the three months ended December 31, 2006, Pinnacle recorded operating revenue of $204.5 million, a decrease of $8.5 million, or four percent, over the same period in 2005. The company's Pinnacle Airlines unit completed 104,566 block hours and 63,060 cycles, a decrease and an increase of 2 percent, respectively, over the same periods in 2005. The decrease in revenue and block hours was primarily attributable to the removal of 15 CRJ aircraft from Pinnacle Airlines' operating fleet in November 2005. Pinnacle Airlines operated an average of 124 aircraft throughout the fourth quarter of 2006, as compared to an average of 129 aircraft during the fourth quarter of 2005. The increase in cycles results from a 5 percent decrease in the average length of Pinnacle's flights from 493 to 469 miles.
Operating income for the fourth quarter 2006 was $61.0 million, or $19.6 million excluding the $41.4 million benefit associated with the changes in reserves related to Northwest receivables. Pinnacle's operating margin for the three months ended December 31, 2006 was 29.8 percent. Excluding the previously mentioned benefit, Pinnacle's margin for the quarter would have been 9.6 percent.
Operating margin for the fourth quarter 2005 was 10.4 percent excluding certain nonrecurring charges. Pinnacle expects that its first quarter 2007 operating income will also be negatively impacted by additional ground handling transition costs and by pilot labor and training costs associated with the addition of 15 CRJ-200 aircraft during the quarter.
For the 12 months ended December 31, 2006, Pinnacle recorded operating revenue of $824.6 million, a decrease of $17.0 million, or two percent, over the same period in 2005. For the period, Pinnacle Airlines completed 415,069 block hours and 251,091 cycles, a decrease of four percent and an increase of one percent, respectively, over the same periods in 2005. While block hours decreased owing to the decrease in fleet size, cycles increased because of a six percent decrease in the average length of Pinnacle's flights from 500 to 470 miles.
Operating income for the full year 2006 was $127.5 million, or $85.3 million excluding the $43.6 million benefit associated with the previously mentioned nonrecurring items and the $1.3 million charge related to pilot post-retirement benefits. Pinnacle's operating margin for 2006 was 15.5 percent. Excluding the nonrecurring items, Pinnacle's margin for 2006 would have been 10.3 percent. Operating income for 2005 was $26.9 million, or $86.5 million excluding the $59.6 million charge related to the bankruptcies of Northwest and Mesaba. Operating margin for 2005 was 3.2 percent or 10.3 percent excluding those charges.
Pinnacle is currently under Internal Revenue Service review for the tax years 2003, 2004 and 2005. As a result, Pinnacle recorded an increase in income tax expense of $1.5 million in the fourth quarter of 2006 to reserve certain items under review.