Regional carrier Pinnacle has made no secret of the existence of its financial issues, and in December announced the creation of a new restructuring program. But Pinnacle CEO Sean Menke, who joined the company this past May after leaving Frontier in 2010, provided an update on the situation in a letter to employees that was filed with the SEC on Friday.
Menke’s message is incredibly clear, writing that: “on the current path, our financial position will continue to worsen at an alarming rate; we need to act immediately,” and latter adding that “we may ultimately conclude the best way for us to achieve our goal is to use the court-supervised Chapter 11 process.”
Menke attributes Pinnacle’s current challenges to the airline: a longer than expected integration, issues with a new integrated seniority list that came as a result of a new pilot deal, and most interestingly, the nature of its agreements with mainline carriers. Pinnacle currently has four major capacity purchase agreements (CPAs) with mainline carriers.
Pinnacle’s two largest contracts represent 75% of the company’s revenue, and both cover CRJ-200 flying for Delta (one is a legacy Pinnacle contract, the other is a legacy Mesaba agreement). Menke says that these agreements “have historically performed well, and contractual rate adjustments scheduled for 2012 and 2013 will improve the economics in 2012 and beyond.” The agreements have “reasonable contract terms and will continue to be the backbone of our organization.”
But the company’s other agreements do not seem as promising. Menke says Pinnacle’s contract with Delta to operate the CRJ-900 in the Delta Connection network “will benefit from the pilot-related rate adjustment in 2012, there are no additional adjustments throughout the balance of the contract, which begins to wind down in 2017.” Menk adds that the agreement “only produces marginal economics today” and “it will only worsen over time as maintenance and fleet aging expenses surpass contractual rate increases.”
Perhaps the most interesting agreement for Pinnacle is its contract with United/Continental to operate the Bombardier Q400. While the aircraft certainly provides favorable economics, it appears that current agreement between Pinnacle and United/Continental is not sustainable, as Menke writes that the company has “found that the payments being received from United/Continental are not covering the expenses to operate the Q400s.” Menke adds that “the performance of the Q400 CPA will only worsen as this fleet ages and expenses increase.”
Menke’s commentary on the profitability of its contracts is fascinating. On one hand, Republic has touted in the past how it has a great fleet mix compared to its competitors thanks to its larger E-Jets. Yet Pinnacle says that its 50-seat flying is the most profitable. Obviously, it all depends on how the regionals negotiate their deals with the mainline carriers, but it just stood out to me.
Meanwhile, Pinnacle might be the regional carrier in the most precarious situation at the moment, the issue of declining profit margins is certainly not unique or new. This slide from a December Republic investor presentation tells the story better than I can:
I know I’ve said this before, but it will be simply fascinating to see how the regional industry evolves in the coming years. On one hand, common sense would dictate that regional carriers have more bargaining power than in the past thanks to recent consolidation. But at the same time the number of major network carriers has shrunk to four (and that number could shrink further, if the latest media speculation about American is correct).
Meanwhile, the whole issue of pilot scope remains up in the air, as contracts at United, Continental, US Airways, and American are all amendable, while Delta’s contract becomes amendable at the very end of this year.
Pinnacle subleases the 200s from Delta, so they are not responsible for the ownership costs. They do assume those costs for the 900s and Qs, so that could be why those contracts are unfavourable — theye were likely negotiated during another time when regionals could undercut each other — but Pinnacle has grown singficantly since acquiring Colgan nearly five years ago, and the costs of that growth are catching up with the carrier. Would be interesting to compare the stock price when the Colgan and Mesaba acquisitions were announced and now.