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.

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.

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.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Results of Operations

  Consolidated Results of Operations

  The following represents our results of operations, by segment and
consolidated, for the year ended December 31, 2008.

                                                        Year Ended December 31, 2008
                                            Pinnacle      Colgan      Eliminations     Consolidated
                                                               (in thousands)
Operating revenues
Regional airline services                 $  604,166   $  251,493   $            -   $      855,659
Other                                          9,031          203            (108)            9,126
Total operating revenues                     613,197      251,696            (108)          864,785

Operating expenses
Salaries, wages and benefits                 164,775       55,196                -          219,971
Aircraft rentals                             120,932        7,627                -          128,559
Ground handling services                      83,444       13,023            (108)           96,359
Aircraft maintenance, materials and
repairs                                       48,786       44,123                -           92,909
Other rentals and landing fees                53,446       18,411                -           71,857
Aircraft fuel                                      -       49,450                -           49,450
Commissions and passenger related
expense                                        6,160       20,865                -           27,025
Depreciation and amortization                 13,346       13,172                -           26,518
Other                                         68,788       24,194                -           92,982
Impairment of goodwill and aircraft
lease return costs                                 -       13,548                -           13,548
Total operating expenses                     559,677      259,609            (108)          819,178

Operating income (loss)                   $   53,520   $  (7,913)                -           45,607

Operating margin                                8.7%       (3.1)%                -             5.3%

Nonoperating income (expense)
Interest expense                                                                           (34,661)
Impairment of ARS                                                                          (16,800)
Interest income                                                                               6,870
Miscellaneous income, net                                                                       281
Total nonoperating expense                                                                 (44,310)
Income before income taxes                                                                    1,297
Income tax expense                                                                          (6,204)
Net loss                                                                             $      (4,907)

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)

  The following discussion provides an analysis of our consolidated results of
operations and reasons for material changes therein for the year ended December
31, 2008 compared to the same periods in 2007 and 2006. The acquisition of
Colgan was completed on January 18, 2007. As such, Colgan's 2006 data is not
presented and Colgan's 2007 data includes the period from the acquisition date
through December 31, 2007, which represents approximately 94% of that year.
                                              % Change                         % Change
                                2008         2008 - 2007         2007         2007 - 2006         2006
Total operating revenue      $  864,785               10%     $  787,374              (5)%     $  824,623
Total operating expenses        819,178               11%        734,963                5%        697,075
Operating income                 45,607             (13)%         52,411             (59)%        127,548
Operating margin                   5.3%                             6.7%                            15.5%

Total nonoperating expense     (44,310)            3,125%        (1,374)             (53)%        (2,948)

Income before income taxes        1,297             (97)%         51,037             (59)%        124,600
Income tax expense              (6,204)             (62)%       (16,400)             (65)%       (46,801)
Net (loss) income               (4,907)            (114)%         34,637             (55)%         77,799

2008 Compared to 2007

Operating Revenue

Operating revenue of $864.8 million for the year ended December 31, 2008 increased $77.4 million, or 10%, over the year ended December 31, 2007. This increase was primarily related to an increase in our capacity purchase revenue. During 2008, we added 15 Q400 aircraft and 17 CRJ-900 aircraft, including the seven Temporary Aircraft, to our operating fleet. This was partially offset by a 7% decrease in the average number of CRJ-200 aircraft we operate under our CRJ-200 ASA. Our pro-rate revenue increased slightly as a result of a 15% increase in average fare, offset by an 11% decrease in passengers. These changes are discussed in greater detail within our segmented results of operations.

Operating Expenses

Operating expenses increased by $84.2 million, or 11%, during the year ended December 31, 2008, primarily due to increases in block hours and departures associated with the growth in our operating fleet. In addition, operating expenses increased as a result of increased fuel prices related to our pro-rate operations, increased depreciation expense following the addition of our recently purchased CRJ-900 and Q400 aircraft, increased unreimbursed maintenance costs incurred on our aging CRJ-200 fleet, impairment charges primarily related to Colgan's goodwill, Colgan's lease return costs, and increased compensation expense resulting from the addition of employees to support the growth of our business. These changes are discussed in greater detail within our segmented results of operations.

Nonoperating Expense

Net nonoperating expense of $44.3 million for the year ended December 31, 2008 increased by approximately $42.9 million over net nonoperating expense of $1.4 million during 2007. This increase is attributable to the $25.8 million increase in interest expense, primarily related to the financing of the CRJ-900 and Q400 aircraft, the majority of which were delivered and financed during 2008. Interest income decreased by $4.7 million, due to a lower average invested balance throughout 2008 as compared to 2007. In addition, we recorded a $16.8 million impairment charge related to the decline in the fair values of our ARS portfolio. Net nonoperating expense for the year ended December 31, 2007 was affected by a $4.1 million loss related to the sale of our remaining Northwest unsecured claim.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

Income Tax Expense

For the year ended December 31, 2008, our income tax expense decreased by $10.2 million, primarily related to the decrease in pre-tax income as compared to 2007. Partially offsetting the decline of income tax expense is the valuation allowance we recorded against the tax benefit related to the $16.8 million ARS impairment charge. This valuation allowance was recorded because the loss cannot offset ordinary income, and we expect no capital gains during the carryforward period of this loss.

2007 Compared to 2006

Operating Revenues

Operating revenue of $787.4 million for the year ended December 31, 2007 decreased $37.2 million, or 5%, over the year ended December 31, 2006. The decrease in revenue was primarily due to the decrease in revenue associated with expense reimbursements from Northwest and a reduction in Pinnacle's target operating margin of 10% in 2006 to 8% effective January 1, 2007. The most significant decreases in reimbursable expenses were aircraft fuel and aircraft rent. Under the CRJ-200 ASA, jet fuel is provided to Pinnacle at no cost, whereas in 2006, jet fuel was a reimbursable expense. Also under the CRJ-200 ASA, our aircraft rental expense has been lowered to a rate that approximated market rates at that time. These changes to the CRJ-200 ASA caused a decrease of revenue of $323.8 million. These decreases are offset by the recognition of deferred CRJ-200 ASA revenue of $22.6 million. For more information regarding deferred CRJ-200 ASA revenue, see Note 3 in Item 8 of this Form 10-K. The remaining 6% increase is related to the 6% increase in block hours and departures due to an increase in Pinnacle's fleet compared to 2006. In addition, these revenue decreases are offset by the addition of $192.4 million in revenue related to Colgan. These changes are discussed in greater detail within our segmented results of operations.

Operating Expenses

Operating expenses increased by $37.9 million, or 5%, during the year ended December 31, 2007, primarily related to the addition of Colgan's operating expenses, which totaled $197.5 million for 2007. In addition, Pinnacle's operating expense increased as a result of the 6% increase in block hours and departures. This increase was offset by a decrease of $242.9 million in fuel and aircraft rent expense, primarily related to the aforementioned changes to our CRJ-200 ASA. These changes are discussed in greater detail within our segmented results of operations.

Nonoperating Expense

Net nonoperating expense decreased by $1.6 million, as compared to the same period in 2006. The increase was caused by a $3.3 million increase in interest expense, largely attributable to Colgan's operations, offset by $2.9 million of capitalized interest, primarily related to the acquisition of our Q400 and CRJ-900 aircraft. In addition, miscellaneous expense increased by $4.1 million related to the $4.1 million loss we recorded on the sale of our $42.5 million bankruptcy claim against Northwest during the second quarter of 2007. Further offsetting the increase in nonoperating expense is a $9.1 million increase in interest income from our significantly larger ARS portfolio. The increase in our portfolio relates to the investment of proceeds received from the assignment of our Northwest and Mesaba claims.

Income Tax Expense

For the year ended December 31, 2007, our income tax expense decreased $30.4 million, primarily related to the decrease in pre-tax income as compared to 2006. In addition, due to the tax free interest income on our ARS portfolio, the Company's effective tax rate decreased by 5.5 points.

Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations (continued)

  Segmented Results of Operations

 The following represents our results of operations, by segment, for the years
ended December 31, 2008, 2007 and 2006 (in thousands):

  Pinnacle Operating Statistics

                                                   % Change                      % Change
                                     2008         2008-2007         2007         2007-2006        2006

Revenue passengers (in
thousands)                             10,393             4%           9,996           11%           8,988
Revenue passenger miles
("RPMs") (in thousands)             4,844,526             5%       4,620,861            8%       4,288,551
Available seat miles ("ASMs")
(in thousands)                      6,320,269             5%       6,004,680            6%       5,640,629
Passenger load factor                   76.7%     (0.3) pts.           77.0%      1.0 pts.           76.0%
Operating revenue per ASM (in
cents)                                   9.70           (2)%            9.91         (32)%           14.62
Operating cost per ASM (in
cents)                                   8.86           (1)%            8.96         (28)%           12.36
Operating revenue per block
hour                              $     1,384             2%     $     1,356         (32)%     $     1,987
Operating cost per block hour     $     1,264             3%     $     1,225         (27)%     $     1,679
Block hours                           442,911             1%         438,988            6%         415,069
Departures                            267,893             1%         265,418            6%         251,091
Average daily utilization
(block hours)                            8.78             1%            8.73          (5)%            9.17
Average stage length (miles)              460             1%             455          (3)%             470

Number of operating aircraft
(end of period)
  CRJ-200                                 124           (9)%             137           10%             124
  CRJ-900                               18(1)          1700%               1          100%               -
Employees (end of period)               4,204             5%           4,008            4%           3,860

(1) On October 1, 2008, we entered into an agreement with Delta to operate on a short-term basis seven additional CRJ-900 aircraft (the "Temporary Aircraft"). For further discussion, refer to Note 3, Code-share Agreements with Partners, in Item 8 of this Form 10-K.

  Pinnacle Operating Revenues

                                                 % Change                      % Change
                                    2008        2008 - 2007       2007        2007 - 2006       2006
Operating revenues:
  Regional airline services
      CRJ-200 ASA                 $ 569,020            (2)%     $ 583,591           (29)%     $ 816,787
              DCA                    35,146          2,268%         1,484            100%             -
 Other                                9,031            (9)%         9,978             27%         7,836
Total operating revenues          $ 613,197            3.0%     $ 595,053           (28)%     $ 824,623

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)

2008 Compared to 2007

Regional Airline Services

For the year ended December 31, 2008, revenue earned under our CRJ-200 ASA of $569.0 million decreased by $14.6 million, or 2%, as compared to 2007. Revenue earned under our CRJ-200 ASA was negatively affected by the return of 15 CRJ-200 aircraft pursuant to the terms of our CRJ-200 ASA. During the year ended December 31, 2008, on average we operated 7% fewer CRJ-200 aircraft as compared . . .