SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2005
---------------------------------------------
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 0-16079
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AIR METHODS CORPORATION
-----------------------
(Exact name of Registrant as Specified in Its Charter)
Delaware 84-0915893
-------- ----------
(State or Other Jurisdiction of (IRS Employer
Incorporation or Organization) Identification Number)
7301 South Peoria, Englewood, Colorado 80112
------------------------------------------ -----
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (303) 792-7400
--------------
Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report: N/A
Indicate by check mark whether the 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
--- ---
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 number of shares of Common Stock, par value $.06, outstanding as of October
28, 2005, was 11,052,055.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - September 30, 2005 and
December 31, 2004 (unaudited) 1
Consolidated Statements of Operations for the three and nine
months ended September 30, 2005 and 2004 (unaudited) 3
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2005 and 2004 (unaudited) 5
Notes to Consolidated Financial Statements (unaudited) 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 14
Item 3. Quantitative and Qualitative Disclosures about Market Risk 26
Item 4. Controls and Procedures 27
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Changes in Securities 28
Item 3. Defaults upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 28
Item 5. Other Information 28
Item 6. Exhibits 28
SIGNATURES 29
PART I: FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2005 2004
------------------------------
Assets
- ------
Current assets:
Cash and cash equivalents $ 3,066 2,603
Current installments of notes receivable 64 61
Receivables:
Trade 122,976 89,218
Less allowance for doubtful accounts (42,739) (26,040)
------------------------------
80,237 63,178
Other 2,284 4,520
------------------------------
Total receivables 82,521 67,698
------------------------------
Inventories 9,128 8,667
Work-in-process on medical interiors and products contracts 1,550 645
Assets held for sale -- 5,705
Costs and estimated earnings in excess of billings on
uncompleted contracts 2,611 2,938
Prepaid expenses and other 2,437 2,686
------------------------------
Total current assets 101,377 91,003
------------------------------
Property and equipment:
Land 190 190
Flight and ground support equipment 140,700 137,742
Furniture and office equipment 12,532 11,805
------------------------------
153,422 149,737
Less accumulated depreciation and amortization (60,704) (52,985)
------------------------------
Net property and equipment 92,718 96,752
------------------------------
Goodwill 6,485 6,485
Notes receivable, less current installments 116 572
Other assets, net of accumulated amortization of $2,585 and $2,108
at September 30, 2005 and December 31, 2004, respectively 9,377 9,911
------------------------------
Total assets $ 210,073 204,723
==============================
(Continued)
1
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, CONTINUED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2005 2004
----------------------------
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities:
Notes payable $ -- 5,105
Current installments of long-term debt (note 3) 11,331 6,041
Current installments of obligations under capital leases 563 410
Accounts payable 8,151 7,193
Deferred revenue 3,216 3,883
Billings in excess of costs and estimated earnings on
uncompleted contracts 262 309
Accrued wages and compensated absences 8,137 3,668
Deferred income taxes 1,771 4,387
Due to third party payers 2,105 2,867
Other accrued liabilities 5,190 8,291
----------------------------
Total current liabilities 40,726 42,154
Long-term debt, less current installments (note 3) 59,887 72,693
Obligations under capital leases, less current installments 459 249
Deferred income taxes 16,306 8,284
Other liabilities 11,027 8,264
----------------------------
Total liabilities 128,405 131,644
----------------------------
Stockholders' equity (note 5):
Preferred stock, $1 par value. Authorized 5,000,000 shares,
none issued -- --
Common stock, $.06 par value. Authorized 16,000,000 shares;
issued 11,052,055 and 10,997,380 shares at September 30, 2005
and December 31, 2004, respectively 663 660
Additional paid-in capital 65,187 64,955
Retained earnings 15,818 7,464
Treasury stock at par, 4,040 common shares at
December 31, 2004 -- --
----------------------------
Total stockholders' equity 81,668 73,079
----------------------------
Total liabilities and stockholders' equity $ 210,073 204,723
============================
<FN>
See accompanying notes to consolidated financial statements.
2
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------
2005 2004 2005 2004
------------------------------------------------
Revenue:
Flight revenue $ 88,094 66,958 240,917 199,396
Sales of medical interiors and products 2,415 1,973 5,739 5,358
Parts and maintenance sales and services 24 18 70 84
Gain on disposition of assets, net 5 -- -- --
------------------------------------------------
90,538 68,949 246,726 204,838
------------------------------------------------
Operating expenses:
Flight centers 28,265 23,979 80,542 70,142
Aircraft operations 16,119 16,081 47,857 44,688
Aircraft rental 4,608 3,911 13,370 10,773
Medical interiors and products sold 1,626 641 3,622 1,818
Cost of parts and maintenance sales and services 23 19 88 103
Depreciation and amortization 3,022 2,729 8,890 8,140
Bad debt expense 17,834 8,926 44,181 34,147
Loss on disposition of assets, net -- 8 376 34
General and administrative 9,146 8,643 26,974 24,156
------------------------------------------------
80,643 64,937 225,900 194,001
------------------------------------------------
Operating income 9,895 4,012 20,826 10,837
Other income (expense):
Interest expense (1,228) (1,816) (4,646) (5,936)
Loss on early extinguishment of debt (note 3) -- -- (3,104) --
Other, net 361 182 694 745
------------------------------------------------
Income before income tax expense and cumulative effect
of change in accounting principle 9,028 2,378 13,770 5,646
Income tax expense 3,530 926 5,416 2,220
------------------------------------------------
Income before cumulative effect of change in accounting
principle 5,498 1,452 8,354 3,426
Cumulative effect of change in method of accounting for
maintenance costs, net of income taxes (note 2) -- -- -- 8,595
------------------------------------------------
Net income $ 5,498 1,452 8,354 12,021
================================================
(Continued)
3
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS, CONTINUED
(AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-----------------------------------------------
2005 2004 2005 2004
-----------------------------------------------
Basic income per common share (note 4):
Income before cumulative effect of change in accounting
principle $ .50 .13 .76 .32
Cumulative effect of change in method of accounting for
maintenance costs, net of income taxes -- -- -- .79
-----------------------------------------------
Net income $ .50 .13 .76 1.11
===============================================
Diluted income per common share (note 4):
Income before cumulative effect of change in accounting
principle $ .47 .13 .72 .30
Cumulative effect of change in method of accounting for
maintenance costs, net of income taxes -- -- -- .76
-----------------------------------------------
Net income $ .47 .13 .72 1.06
===============================================
Weighted average number of common shares outstanding -
basic 11,034,754 10,921,369 11,020,936 10,873,783
===============================================
Weighted average number of common shares outstanding -
diluted 11,634,024 11,296,854 11,536,716 11,272,876
===============================================
<FN>
See accompanying notes to consolidated financial statements.
4
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------
2005 2004
---------------------------------------
Cash flows from operating activities:
Net income $ 8,354 12,021
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization expense 8,890 8,140
Bad debt expense 44,181 34,147
Deferred income tax expense 5,406 2,229
Loss on retirement and sale of equipment, net 376 34
Loss on early extinguishment of debt 3,104 --
Cumulative effect of change in method of accounting for maintenance -- (8,595)
Changes in assets and liabilities:
Decrease (increase) in prepaid expenses and other current assets 300 (715)
Increase in receivables (59,004) (37,243)
Decrease (increase) in inventories (461) 264
Increase in work-in-process on medical interiors and costs in excess of
billings (578) (496)
Increase in accounts payable, other accrued liabilities, and other
liabilities 4,327 1,874
Increase (decrease) in deferred revenue and billings in excess of costs (714) 1,517
---------------------------------------
Net cash provided by operating activities 14,181 13,177
---------------------------------------
Cash flows from investing activities:
Acquisition of property and equipment (3,878) (9,378)
Proceeds from disposition and sale of equipment 1,070 1,217
Decrease (increase) in notes receivable and other assets (341) 1,447
---------------------------------------
Net cash used by investing activities (3,149) (6,714)
---------------------------------------
(Continued)
5
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
-----------------------------------
2005 2004
-----------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net $ 235 771
Payments for purchases of common stock -- (453)
Net repayments under line of credit (353) (86)
Proceeds from issuance of long-term debt 20,000 8,531
Payments for debt issue costs (431) (435)
Payments of long-term debt (28,171) (12,317)
Debt retirement costs (1,380) --
Payments of capital lease obligations (469) (587)
-----------------------------------
Net cash used by financing activities (10,569) (4,576)
-----------------------------------
Increase in cash and cash equivalents 463 1,887
Cash and cash equivalents at beginning of period 2,603 5,574
-----------------------------------
Cash and cash equivalents at end of period $ 3,066 7,461
===================================
Non-cash investing and financing activities:
In the nine months ended September 30, 2005, the Company settled notes payable
of $5,105 in exchange for the aircraft securing the debt. The Company also
settled a note payable totaling $346 by applying a purchase deposit against it
and entered into a note payable of $396 to finance insurance policies and into
capital lease obligations of $832 to finance the purchase of equipment.
In the nine months ended September 30, 2005, the Company wrote off $1,724 in
debt origination costs and note discount related to the retirement of its
subordinated debt.
Effective January 1, 2004, the Company changed its method of accounting for
major engine and airframe component overhaul costs from the accrual method of
accounting to the direct expense method. Accordingly, the Company reversed its
major overhaul accrual totaling $33,809 for all owned and leased aircraft and
reversed the remaining capitalized maintenance included in fixed assets relating
to used aircraft purchases totaling $19,719, with the balance reflected as the
cumulative effect of change in accounting principle of $8,595 ($14,090, net of
income taxes of $5,495).
In the nine months ended September 30, 2004, the Company settled a note payable
totaling $424 by applying a purchase deposit against it. The Company also
entered into a note payable of $189 to finance insurance policies.
In the nine months ended September 30, 2004, the Company entered into a note
payable of $4,748 to finance the purchase of an aircraft which was held for sale
as of September 30, 2004.
See accompanying notes to consolidated financial statements.
6
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
---------------------
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and
Regulation S-X. Accordingly, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting of only normal
recurring accruals) necessary to present fairly the consolidated financial
statements for the respective periods. Interim results are not necessarily
indicative of results for a full year. The consolidated financial
statements should be read in conjunction with the Company's audited
consolidated financial statements and notes thereto for the year ended
December 31, 2004.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period. The Company
considers its critical accounting policies involving more significant
judgments and estimates to be those related to revenue recognition,
uncollectible receivables, deferred income taxes, and depreciation and
residual values. Actual results could differ from those estimates.
Certain prior period amounts have been reclassified to conform with the
2005 presentation.
(2) ACCOUNTING CHANGE
------------------
Effective January 1, 2004, the Company changed its method of accounting for
major engine and airframe component overhaul costs from the accrual method
of accounting to the direct expense method. Under the new accounting
method, maintenance costs are recognized as expense as maintenance services
are performed. The Company believes the direct-expense method is preferable
in the circumstances because the maintenance liability is not recorded
until there is an obligating event (when the maintenance event is actually
being performed), the direct expense method eliminates significant
estimates and judgments inherent under the accrual method, and it is the
predominant method used in the transportation industry. Accordingly,
effective January 1, 2004, the Company reversed its major overhaul accrual
totaling $33,809,000 for all owned and leased aircraft and reversed the
remaining capitalized maintenance included in fixed assets relating to used
aircraft purchases totaling $19,719,000, with the balance reflected as the
cumulative effect of change in accounting principle of $8,595,000
($14,090,000, net of income taxes of $5,495,000).
In 2002, the impact of the major overhaul accrual relating to aircraft
purchased in the Rocky Mountain Holdings, LLC (RMH) acquisition was
considered a component of the valuation of the aircraft and did not affect
the allocation of the purchase price to goodwill. Accordingly, the change
in method to the direct expense method in 2004 resulted in a reduction in
the asset value assigned to RMH aircraft. The amount of the cumulative
effect of the change in accounting principle related to RMH aircraft was
due exclusively to depreciation of the asset value or changes in the
liability balances which had been expensed subsequent to the acquisition.
Therefore, the majority of the cumulative effect of the change in
accounting principle related to aircraft which were in the Company's fleet
prior to the RMH acquisition.
7
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(3) LONG-TERM DEBT
---------------
On May 9, 2005, the Company amended and restated its senior revolving
credit facility and repaid its subordinated debt facility. The amendment
provided for, among other things, $20 million of term loans, an extension
of the maturity date to March 31, 2010, and modifications to the financial
covenants. The proceeds from the term loans, along with additional
borrowings under the revolving credit facility, were used to repay the
Company's $23 million of subordinated debt. The term loans and the
revolving loans bear interest, at the Company's option, at either (i) the
higher of the federal funds rate plus 0.50% or the prime rate as announced
by the lenders plus an applicable margin ranging from 0.50% to 1.50% or
(ii) a rate equal to LIBOR plus an applicable margin ranging from 1.75% to
3.75%. Principal payments on the term loans will commence in April 2006 and
total $4.5 million in 2006, $6 million in 2007, $3 million in 2008, $2
million in 2009, and $4.5 million in 2010. In the second quarter of 2005,
the Company wrote off $1,724,000 in debt origination costs and note
discount related to the subordinated debt and paid a prepayment penalty of
$1,380,000 to the holders of the subordinated debt. In 2005 the effective
interest rate on the subordinated debt, including amortization of debt
origination costs and note discount, was 16.2%. Long-term debt consisted of
the following at September 30, 2005, and December 31, 2004 (amounts in
thousands):
September 30, December 31,
2005 2004
------------------------------
Subordinated notes payable, net of discount $ -- 21,860
New term loans (as described above) 20,000 --
Borrowings under revolving credit facility 14,366 14,719
Other notes payable 36,852 42,155
------------------------------
71,218 78,734
Less current installments (11,331) (6,041)
------------------------------
$ 59,887 72,693
==============================
(4) INCOME PER SHARE
------------------
Basic earnings per share is computed by dividing net income by the weighted
average number of common shares outstanding during the period. Diluted
earnings per share is computed by dividing net income by all common shares
and dilutive potential common shares outstanding during the period. The
reconciliation of basic to diluted weighted average common shares
outstanding is as follows:
2005 2004
---------- ----------
FOR QUARTER ENDED SEPTEMBER 30:
Weighted average number of common shares outstanding - basic 11,034,754 10,921,369
Dilutive effect of:
Common stock options 119,672 68,201
Common stock warrants 479,598 307,284
----------------------
Weighted average number of common shares outstanding - diluted 11,634,024 11,296,854
======================
FOR NINE MONTHS ENDED SEPTEMBER 30:
Weighted average number of common shares outstanding - basic 11,020,936 10,873,783
Dilutive effect of:
Common stock options 44,342 90,704
Common stock warrants 471,438 308,389
----------------------
Weighted average number of common shares outstanding - diluted 11,536,716 11,272,876
======================
Common stock options totaling 727,000 were not included in the diluted
income per share calculation for the nine months ended September 30, 2005,
because their effect would have been anti-dilutive. Common stock options
totaling 640,000 were not included in the diluted income per share
calculation for the three and nine months ended September 30, 2004, because
their effect would have been anti-dilutive.
8
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(5) STOCKHOLDERS' EQUITY
---------------------
Changes in stockholders' equity for the nine months ended September 30,
2005, consisted of the following (amounts in thousands except share
amounts):
Shares
Outstanding Amount
--------------------
Balances at January 1, 2005 10,993,340 $73,079
Issuance of common shares for options exercised 58,715 235
Net income -- 8,354
--------------------
Balances at September 30, 2005 11,052,055 $81,668
====================
(6) STOCK-BASED COMPENSATION
-------------------------
The Company accounts for its employee stock compensation plans as
prescribed under Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees (APB Opinion 25). Because the Company grants its
options at or above market value, no compensation cost has been recognized
relating to the plans. Had compensation cost for the Company's stock-based
compensation plans been determined based on the fair value at the grant
dates for awards under those plans consistent with the provisions of FASB
Statement 123, the Company's net income and income per share would have
been reduced to the pro forma amounts indicated below (amounts in
thousands, except per share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
-----------------------------------------------
Net income before cumulative effect of change in
accounting principle:
As reported $ 5,498 1,452 8,354 3,426
Pro forma 5,306 1,379 8,011 3,208
Net income:
As reported $ 5,498 1,452 8,354 12,021
Pro forma 5,306 1,379 8,011 11,803
Basic income per share before cumulative effect
of change in accounting principle:
As reported $ .50 .13 .76 .32
Pro forma .48 .13 .73 .30
Basic income per share:
As reported $ .50 .13 .76 1.11
Pro forma .48 .13 .73 1.09
9
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(6) STOCK-BASED COMPENSATION, CONTINUED
-------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
-------------------------------------------
Diluted income per share before cumulative effect
of change in accounting principle:
As reported $ .47 .13 .72 .30
Pro forma .46 .12 .69 .28
Diluted income per share:
As reported $ .47 .13 .72 1.06
Pro forma .46 .12 .69 1.05
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 2005 and 2004, respectively: dividend yield
of 0%; expected volatility of 36 % and 32%; expected life of 3 and 4 years;
and risk-free interest rates of 4.0% and 3.3% The weighted average fair
value of options granted during the nine months ended September 30, 2005
and 2004, was $2.55 and $2.94, respectively.
In December 2004, the Financial Accounting Standards Board (FASB) issued
FASB Statement No. 123R (Statement 123R), Accounting for Stock-Based
Compensation, an amendment of FASB Statement No. 123. Statement 123R
requires recognition of the grant-date fair value of stock options and
other equity-based compensation issued to employees in the income statement
and provides for either a modified prospective or modified retrospective
transition method for adopting the statement. The statement will be
effective for the Company beginning with the first quarter of 2006. The
Company expects to adopt the modified prospective method of implementation.
Under the modified prospective method, compensation cost is recognized in
the financial statements beginning with the effective date based on the
requirements of Statement 123R for all share-based payments granted after
that date and based on the requirements of Statement 123 for all unvested
awards granted prior to the effective date of Statement 123R. The Company
has not yet determined the financial statement impact of adopting Statement
123R.
10
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(7) BUSINESS SEGMENT INFORMATION
------------------------------
Summarized financial information for the Company's operating segments is
shown in the following table (amounts in thousands). Amounts in the
"Corporate Activities" column represent corporate headquarters expenses,
corporate income tax expense, and results of insignificant operations. The
Company does not allocate assets between HBM, Products, and Corporate
Activities for internal reporting and performance evaluation purposes.
Operating segments and their principal products or services are as follows:
- Community-Based Model (CBM) - provides air medical transportation
services to the general population as an independent service in 17
states. Services include aircraft operation and maintenance, medical
care, dispatch and communications, and medical billing and collection.
- Hospital-Based Model (HBM) - provides air medical transportation
services to hospitals in 26 states and Puerto Rico under exclusive
operating agreements. Services include aircraft operation and
maintenance.
- Products Division - designs, manufactures, and installs aircraft
medical interiors and other aerospace and medical transport products
for domestic and international customers.
Products Corporate Intersegment
FOR QUARTER ENDED SEPTEMBER 30: CBM HBM Division Activities Eliminations Consolidated
-------------------------------------------------------------------------------------------------------
2005
External revenue $61,831 26,292 2,415 -- -- 90,538
Intersegment revenue -- -- 1,501 -- (1,501) --
---------------------------------------------------------------------
Total revenue 61,831 26,292 3,916 -- (1,501) 90,538
---------------------------------------------------------------------
Operating expenses 34,635 21,094 2,990 2,211 (1,143) 59,787
Depreciation & amortization 1,539 1,299 110 74 -- 3,022
Bad debt expense 17,534 300 -- -- -- 17,834
Interest expense 658 544 -- 26 -- 1,228
Other, net (274) -- -- (87) -- (361)
Income tax expense -- -- -- 3,530 -- 3,530
---------------------------------------------------------------------
Segment net income (loss) $ 7,739 3,055 816 (5,754) (358) 5,498
=====================================================================
Total assets $83,463 N/A N/A 128,774 (2,164) 210,073
=====================================================================
2004
External revenue $43,507 23,469 1,973 -- -- 68,949
Intersegment revenue -- -- 1,674 -- (1,674) --
---------------------------------------------------------------------
Total revenue 43,507 23,469 3,647 -- (1,674) 68,949
---------------------------------------------------------------------
Operating expenses 30,121 20,220 2,282 2,219 (1,560) 53,282
Depreciation & amortization 1,342 1,261 74 52 -- 2,729
Bad debt expense 8,696 230 -- -- -- 8,926
Interest expense 920 871 -- 25 -- 1,816
Other, net (237) -- -- 55 -- (182)
Income tax expense -- -- -- 926 -- 926
---------------------------------------------------------------------
Segment net income (loss) $ 2,665 887 1,291 (3,277) (114) 1,452
=====================================================================
Total assets $65,821 N/A N/A 142,055 (2,164) 205,712
=====================================================================
11
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(7) BUSINESS SEGMENT INFORMATION, CONTINUED
---------------------------------------
Products Corporate Intersegment
FOR NINE MONTHS ENDED SEPTEMBER 30: CBM HBM Division Activities Eliminations Consolidated
-------------------------------------------------------------------------------------------------------------
2005
External revenue $167,026 73,961 5,739 -- -- 246,726
Intersegment revenue -- -- 5,946 -- (5,946) --
----------------------------------------------------------------------
Total revenue 167,026 73,961 11,685 -- (5,946) 246,726
----------------------------------------------------------------------
Operating expenses 101,174 60,875 8,842 6,585 (4,647) 172,829
Depreciation & amortization 4,483 3,890 316 201 -- 8,890
Bad debt expense 43,527 654 -- -- -- 44,181
Interest expense 2,427 2,140 -- 79 -- 4,646
Loss on early extinguishment of debt -- -- -- 3,104 3,104
Other, net (733) -- -- 39 -- (694)
Income tax expense -- -- -- 5,416 -- 5,416
----------------------------------------------------------------------
Segment net income (loss) $ 16,148 6,402 2,527 (15,424) (1,299) 8,354
======================================================================
Total assets $ 83,463 N/A N/A 128,774 (2,164) 210,073
======================================================================
2004
External revenue $133,390 66,090 5,358 -- -- 204,838
Intersegment revenue -- -- 5,607 -- (5,607) --
----------------------------------------------------------------------
Total revenue 133,390 66,090 10,965 -- (5,607) 204,838
----------------------------------------------------------------------
Operating expenses 86,310 57,083 7,026 6,250 (4,955) 151,714
Depreciation & amortization 4,051 3,757 182 150 -- 8,140
Bad debt expense 33,917 230 -- -- -- 34,147
Interest expense 2,976 2,817 -- 143 -- 5,936
Other, net (690) -- -- (55) -- (745)
Income tax expense -- -- -- 2,220 -- 2,220
----------------------------------------------------------------------
Segment net income (loss) before
cumulative effect of change in
accounting principle 6,826 2,203 3,757 (8,708) (652) 3,426
Cumulative effect of change in
accounting principle, net -- -- -- 8,595 -- 8,595
----------------------------------------------------------------------
Segment net income (loss) $ 6,826 2,203 3,757 (113) (652) 12,021
======================================================================
Total assets $ 65,821 N/A N/A 142,055 (2,164) 205,712
======================================================================
12
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(8) SUBSEQUENT EVENT
----------------
In September 2003, the Company's pilots voted to be represented by the
Office and Professional Employees International Union, Local 109.
Negotiations on a collective bargaining agreement began in early 2004 and
consensus has been reached on a majority of the non-economic issues under
consideration. However, the economic demands of the union have continued to
be significantly higher than the Company's offers. In November 2005, the
Company provided a settlement offer to the union which included changes to
base salary and overtime pay and to the Company's contribution to defined
contribution retirement plans (401k plans). Under the Company's proposed
settlement, pay for overtime shifts would increase from regular pay rates
to 1.5 times regular pay rates. The Company currently maintains two 401k
plans. Under one plan, the Company contributes 2% of gross pay for all
eligible employees and matches 60% of the employees' contributions up to 6%
of their gross pay. Under the other plan, the Company matches 30% of the
employees' contributions up to 6% of their gross pay. In the proposed
settlement, the Company will contribute up to 5.6% of gross pay to both
401k plans, depending on the level of each employee's participation. The
estimated impact of the proposed change in base salary is $2.8 million in
the year of implementation. Because the impact of changes to overtime pay
and to the 401k plan contributions is dependent upon staffing levels and
employee participation in the 401k plans, the effect on the Company's
financial statements cannot presently be quantified. The Company has also
not yet determined the extent to which, if any, the impact of the
settlement offer may be offset by price increases. There can be no
assurance that the Company's offer will be accepted by the union or that
the Company will not be subject to a work stoppage if the parties are
unable to come to an agreement.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of the results of operations and financial condition
should be read in conjunction with the Company's consolidated financial
statements and notes thereto included in Item 1 of this report. This report,
including the information incorporated by reference, contains forward-looking
statements as defined in the Private Securities Litigation Reform Act of 1995.
The use of any of the words "believe," "expect," "anticipate," "plan,"
"estimate," and similar expressions are intended to identify such statements.
Forward-looking statements include statements concerning possible or assumed
future results of the Company; size, structure and growth of the Company's air
medical services and products markets; continuation and/or renewal of HBM
contracts; acquisition of new and profitable Products Division contracts; flight
volume and collection rates for CBM operations; and other matters. The actual
results that the Company achieves may differ materially from those discussed in
such forward-looking statements due to the risks and uncertainties described in
Management's Discussion and Analysis of Financial Condition and Results of
Operations, and in other sections of this report, as well as in the Company's
annual report on Form 10-K. The Company undertakes no obligation to update any
forward-looking statements.
OVERVIEW
The Company provides air medical transportation services throughout the United
States and designs, manufactures, and installs medical aircraft interiors and
other aerospace products for domestic and international customers. The Company's
divisions, or business segments, are organized according to the type of service
or product provided and consist of the following:
- - Community-Based Model (CBM) - provides air medical transportation services
to the general population as an independent service. Revenue consists of
flight fees billed directly to patients, their insurers, or governmental
agencies, and cash flow is dependent upon collection from these individuals
or entities. In the nine months ended September 30, 2005, the CBM Division
generated 68% of the Company's total revenue, increasing from 65% in the
nine months ended September 30, 2004.
- - Hospital-Based Model (HBM) - provides air medical transportation services
to hospitals throughout the U.S. under exclusive operating agreements.
Revenue consists of fixed monthly fees (approximately 62% of total contract
revenue) and hourly flight fees (approximately 38% of total contract
revenue) billed to hospital customers. In the nine months ended September
30, 2005, the HBM Division generated 30% of the Company's total revenue,
decreasing from 32% in 2004.
- - Products Division - designs, manufactures, and installs aircraft medical
interiors and other aerospace and medical transport products for domestic
and international customers. In 2005 the Products Division generated 2% of
the Company's total revenue, compared to 3% in 2004.
See Note 7 to the consolidated financial statements included in Item 1 of this
report for operating results by segment.
The Company believes that the following factors have the greatest impact on its
results of operations and financial condition:
- - FLIGHT VOLUME. Fluctuations in flight volume have a greater impact on CBM
operations than HBM operations because 100% of CBM revenue is derived from
flight fees, as compared to approximately 38% of HBM revenue. By contrast,
approximately 62% of the Company's costs primarily associated with flight
operations (including salaries, aircraft ownership costs, hull insurance,
and general and administrative expenses) are mainly fixed in nature. While
flight volume is affected by many factors, including competition and the
distribution of calls within a market, the greatest single factor has
historically been weather conditions. Adverse weather conditions-such as
fog, high winds, or heavy precipitation-hamper the Company's ability to
operate its aircraft safely and, therefore, result in reduced flight
volume. In recent years, the air medical transportation industry has
experienced an increase in the rate of base expansion, especially for CBM
operations. Continued growth in capacity may have a downward pressure on
the flight volume per individual base. Total patient transports for CBM
operations were approximately 8,700 and 24,000 for the quarter and nine
months ended September 30, 2005, respectively, compared to approximately
8,000 and 23,000 for the quarter and nine months ended September 30, 2004,
respectively. Patient transports for CBM bases open longer than one year
(Same-Base Transports) were approximately 8,100 and 22,200 in the quarter
and nine months ended September 30, 2005, respectively, compared to
approximately 7,900 and 22,600 in the quarter and nine months ended
September 30, 2004, respectively. Cancellations due to adverse weather
conditions were approximately 18.7% higher in the nine-month period of 2005
compared to 2004 for bases which had been in operation for longer than one
year.
14
- - RECEIVABLE COLLECTIONS. The Company responds to calls for air medical
transports without pre-screening the creditworthiness of the patient. For
CBM and HBM at-risk operations, bad debt expense is estimated during the
period the related services are performed based on historical collection
experience. The provision is adjusted as required based on actual
collections in subsequent periods. Both the pace of collections and the
ultimate collection rate are affected by the overall health of the U.S.
economy, which impacts the number of indigent patients and funding for
state-run programs, such as Medicaid. Medicaid reimbursement rates in many
jurisdictions have remained well below the cost of providing air medical
transportation. The Company increased prices for its CBM operations
approximately 10% effective September 2004 and an additional 7% effective
March 2005. Net revenue after bad debt expense per transport increased
16.9% and 18.9% for the quarter and nine months ended September 30, 2005,
respectively, compared to the prior year. The total provision for expected
uncollectible amounts, including contractual discounts for
Medicare/Medicaid and bad debts, decreased from 49.3% and 48.5% of related
gross flight revenue for the quarter and nine months ended September 30,
2004, respectively, to 47.5% and 46.4% for the quarter and nine months
ended September 30, 2005, respectively. In 2004 the Company increased
staffing in the billing and collections department, segmented billing by
region, and hired a national billing director. In the third quarter of
2005, the Company also upgraded its software systems for patient billing.
The Company believes that these organizational changes to the billing
department resulted in more timely billing and follow up on outstanding
accounts and, therefore, in an improvement in collection rates.
- - AIRCRAFT MAINTENANCE. Both CBM and HBM operations are directly affected by
fluctuations in aircraft maintenance costs. Proper operation of the
aircraft by flight crews and standardized maintenance practices can help to
contain maintenance costs. Increases in spare parts prices from original
equipment manufacturers (OEM's) tend to be higher for aircraft which are no
longer in production. Three models of aircraft within the Company's fleet,
representing approximately 27% of the rotor wing fleet, have been out of
production for an extended period of time and are, therefore, susceptible
to price increases which outpace general inflationary trends. In addition,
on-condition components are more likely to require replacement with age.
The Company entered into two long-term purchase commitments in 2004 for a
total of 25 aircraft and into an additional purchase commitment in the
third quarter of 2005 for six aircraft. All new aircraft delivered under
these commitments are expected to replace the discontinued models and other
older aircraft over the next five to seven years. As of September 30, 2005,
the Company had taken delivery of ten aircraft under these commitments.
Replacement models of aircraft typically have higher ownership costs than
the models targeted for replacement but lower maintenance costs because of
warranty coverage. Total maintenance expense for CBM and HBM operations
decreased 6.3% in the third quarter of 2005 compared to the third quarter
of 2004 and increased 4.9% in the nine months ended September 30, 2005,
compared to 2004. Total flight volume for CBM and HBM operations increased
14.0% and 9.4%, respectively, over the same periods. In the third quarter
of 2005, the Company began to realize some of the benefits of its efforts
to modernize its fleet, as deliveries of new aircraft allowed the Company
to redeploy some older models into lower utilization markets or into the
backup fleet. In addition, engine upgrades performed in prior periods and
standard pricing contracts covering several key components of certain
models of aircraft contributed to lower operating costs during the third
quarter of 2005. Fewer engine overhauls were performed during the third
quarter of 2005 compared to the prior year, due to normal operating cycles.
- - COST PRESSURES ON HEALTHCARE INSTITUTIONS. Publicly and privately funded
healthcare institutions both face pressures to reduce the rising cost of
healthcare and to modify or eliminate certain non-core operations as a
result of reductions in funding. Flight programs based at a single hospital
typically require subsidization from other hospital operations. As a
result, a growing number of healthcare institutions are evaluating their
delivery model for air medical transportation services, creating expansion
opportunities for CBM operations. In the first quarter of 2005, the CBM
division commenced operations at two new bases in California which had
previously been a hospital-based flight program with another operator.
Within the past two years, two of the Company's HBM customers have opted to
retain the Company's services to expand their operations to satellite bases
under a risk-sharing model. The Company expects the trend toward conversion
of HBM programs to CBM operations to continue as healthcare institutions
recognize the viable alternatives available for outsourcing.
15
- - COMPETITIVE PRESSURES FROM LOW-COST PROVIDERS. The Company is recognized
within the industry for its standard of service and its use of cabin-class
aircraft. Many of the Company's regional competitors utilize aircraft with
lower ownership and operating costs and do not require a similar level of
experience for aviation and medical personnel. Reimbursement rates
established by Medicare, Medicaid, and most insurance providers are not
contingent upon the type of aircraft used or the experience of the aviation
and medical personnel. However, the Company believes that higher quality
standards help to differentiate its service from competitors and,
therefore, lead to higher utilization. Deploying multiple aircraft in a
market also serves as a barrier to entry for lower cost providers.
- - EMPLOYEE RELATIONS. In September 2003, the Company's pilots voted to be
represented by the Office and Professional Employees International Union,
Local 109. Negotiations on a collective bargaining agreement began in early
2004 and consensus has been reached on a majority of the non-economic
issues under consideration. However, the economic demands of the union have
continued to be significantly higher than the Company's offers. In November
2005, the Company provided a settlement offer to the union which included
changes to base salary and overtime pay and to the Company's contribution
to defined contribution retirement plans (401k plans). Under the Company's
proposed settlement, pay for overtime shifts would increase from regular
pay rates to 1.5 times regular pay rates. The Company currently maintains
two 401k plans. Under one plan, the Company contributes 2% of gross pay for
all eligible employees and matches 60% of the employees' contributions up
to 6% of their gross pay. Under the other plan, the Company matches 30% of
the employees' contributions up to 6% of their gross pay. In the proposed
settlement, the Company will contribute up to 5.6% of gross pay to both
401k plans, depending on the level of each employee's participation. The
estimated impact of the proposed change in base salary is $2.8 million in
the year of implementation. Because the impact of changes to overtime pay
and to the 401k plan contributions is dependent upon staffing levels and
employee participation in the 401k plan, the effect on the Company's
financial statements cannot presently be quantified. The Company has also
not yet determined the extent to which, if any, the impact of the
settlement offer may be offset by price increases. There can be no
assurance that the Company's offer will be accepted by the union or that
the Company will not be subject to a work stoppage if the parties are
unable to come to an agreement. Other employee groups may also elect to be
represented by unions in the future.
RESULTS OF OPERATIONS
The Company reported net income of $5,498,000 and $8,354,000 for the three and
nine months ended September 30, 2005, respectively, compared to net income of
$1,452,000 and $12,021,000 for the three and nine months ended September 30,
2004, respectively. Net income for the nine months ended September 30, 2005,
included a loss on early extinguishment of debt of $3,104,000 (with a tax effect
of approximately $1,211,000), as discussed more fully in Note 3 to the
consolidated financial statements included in Item 1 of this report. Net income
for the nine months ended September 30, 2004, included the cumulative effect of
a change in accounting principle of $8,595,000 (net of income tax effect of
$5,495,000), as discussed more fully in Note 2 to the consolidated financial
statements included in Item 1 of this report.
Operating income was $9,895,000 and $20,826,000 for the quarter and nine months
ended September 30, 2005, respectively, compared to $4,012,000 and $10,837,000
for the quarter and nine months ended September 30, 2004, respectively. Growth
in operating income for 2005 was partly due to an increase in flight volume for
CBM and HBM operations, resulting primarily from the opening of new bases or
base expansions. In addition, net reimbursement for CBM operations (revenue
after Medicare/Medicaid discounts and bad debt expense) improved 18.8% and 19.7%
for the quarter and nine months ended September 30, 2005, compared to the prior
year.
FLIGHT OPERATIONS - COMMUNITY-BASED MODEL AND HOSPITAL-BASED MODEL
FLIGHT REVENUE increased $21,136,000, or 31.6%, and $41,521,000, or 20.8%, for
the quarter and nine months ended September 30, 2005, respectively, compared to
2004. Flight revenue is generated by both CBM and HBM operations and is recorded
net of Medicare/Medicaid discounts.
- - CBM - Flight revenue increased $18,318,000, or 42.1%, to $61,807,000 for
the third quarter of 2005 and $33,657,000, or 25.2%, to $166,963,000 for
the nine months ended September 30, 2005, for the following reasons:
- Incremental revenue of $4,506,000 and $12,724,000 for the quarter and
nine months ended September 30, 2005, respectively, from the addition
of 10 new CBM bases either during or subsequent to the nine months
ended September 30, 2004.
16
- Closure of three bases either during or subsequent to the nine months
ended September 30, 2004, resulting in a decrease in revenue of
approximately $575,000 and $1,891,000 for the quarter and nine months
ended September 30, 2005, respectively.
- Average price increases of approximately 10% for all CBM operations
effective September 1, 2004, and approximately 7% effective March 1,
2005.
- Change in Same-Base Transports. Excluding the impact of the new bases
and base closures discussed above, total flight volume for all CBM
operations increased 3.2% in the third quarter of 2005 compared to the
third quarter of 2004, but decreased 1.5% in the nine months ended
September 30, 2005, compared to the prior year. The increase in flight
volume during the third quarter is partly attributed to an improvement
in aircraft availability with the deployment of newer models of
aircraft in certain regions. The decrease in flight volume during the
nine-month period is primarily attributed to adverse weather
conditions in the first quarter of 2005. Cancellations due to
unfavorable weather conditions were approximately 30.6% higher in the
first quarter of 2005 compared to the first quarter of 2004.
- Increase caused by a change in payer mix to a lower percentage of
Medicare/Medicaid transports, resulting in lower contractual discounts
which are offset against flight revenue. The decrease in contractual
discounts in 2005 was offset in part by an increase in bad debt
expense. See discussion of total provision for uncollectible accounts,
including contractual discounts and bad debt expense, below under Bad
Debt Expense.
- - HBM - Flight revenue increased $2,818,000, or 12.0%, to $26,287,000 for the
third quarter of 2005 and $7,864,000, or 11.9%, to $73,954,000 for the nine
months ended September 30, 2005, for the following reasons:
- Revenue of $2,122,000 and $5,399,000 for the quarter and nine months
ended September 30, 2005, respectively, from the addition of two new
bases and the expansion of eight contracts either during or subsequent
to the nine months ended September 30, 2004.
- Discontinuation of service under one contract during the first quarter
of 2004, resulting in a decrease in revenue of approximately $88,000
in the nine months ended September 30, 2005.
- Annual price increases in the majority of contracts based on changes
in the Consumer Price Index.
- Increase of 3.9% in flight volume for the quarter ended September 30,
2005, for all contracts excluding the new contracts, contract
expansions, and the discontinued contract discussed above. Flight
volume, taking into account the same exclusions, was basically
unchanged in the nine months ended September 30, 2005, compared to
2004.
FLIGHT CENTER COSTS (consisting primarily of pilot, mechanic, and medical staff
salaries and benefits) increased $4,286,000, or 17.9%, and $10,400,000, or
14.8%, for the quarter and nine months ended September 30, 2005, respectively,
compared to 2004. Flight center costs included an increase of $674,000 in
workers compensation expense for the nine months ended September 30, 2005,
respectively, as a result of two fatal accidents experienced during the first
quarter. Other changes by business segment are as follows:
- - CBM - Flight center costs increased $2,903,000, or 18.9% to $18,240,000 and
$7,438,000, or 16.6%, to $52,199,000 for the quarter and nine months ended
September 30, 2005, for the following reasons:
- Increases of approximately $1,498,000 and $4,962,000 for the quarter
and nine months ended September 30, 2005, for the addition of
personnel to staff new base locations described above.
- Decreases of approximately $351,000 and $1,152,000 for the quarter and
nine months ended September 30, 2005, due to the closure of base
locations described above.
- Increases in salaries for merit pay raises.
- - HBM - Flight center costs increased $1,383,000, or 16.0%, to $10,025,000
and $2,962,000, or 11.7%, to $28,343,000 for the quarter and nine months
ended September 30, 2005, primarily due to the following:
- Increases of approximately $515,000 and $1,529,000 for the quarter and
nine months ended September 30, 2005, for the addition of personnel to
staff new base locations described above.
- Decrease of approximately $35,000 for the nine months ended September
30, 2005, due to the closure of base locations described above.
- Increases in salaries for merit pay raises.
17
AIRCRAFT OPERATING EXPENSES increased $38,000, or 0.2%, and $3,169,000, or 7.1%,
for the quarter and nine months ended September 30, 2005, respectively, in
comparison to the three and nine months ended September 30, 2004. Aircraft
operating expenses consist of fuel, insurance, and maintenance costs and
generally are a function of the size of the fleet, the type of aircraft flown,
and the number of hours flown. The increase in costs is due to the following:
- - Addition of 16 helicopters for CBM operations and 9 for HBM operations
either during or subsequent to the first nine months of 2004, resulting in
increases of approximately $943,000 and $2,909,000 for the three and nine
months ended September 30, 2005, respectively.
- - Increases of approximately $109,000 and $231,000 in fuel costs for the
quarter and nine months ended September 30, 2005, respectively, as a result
of the addition of new CBM bases, net of the impact of closed CBM bases.
The addition of new HBM bases and expansion of HBM programs did not have a
material impact on fuel costs because HBM customers typically pay for all
fuel consumed in medical flights.
- - Increases of approximately 26.2% and 21.9% in the cost of aircraft fuel per
hour flown for the quarter and nine months ended September 30, 2005,
respectively.
- - Decrease in hull insurance rates effective July 2004 and again in July
2005.
- - Decrease in maintenance costs for the third quarter of 2005 compared to the
third quarter of 2004. Excluding the impact of new aircraft described
above, maintenance costs decreased approximately 11.6% during the third
quarter and remained relatively unchanged for the nine-month period of
2005. Engine upgrades performed in prior periods and standard pricing
contracts covering several key components of certain models of aircraft
contributed to lower operating costs during the third quarter. In addition,
deliveries of new aircraft allowed the Company to redeploy some older
models into lower utilization markets or into the backup fleet. Fewer
engine overhauls were also performed during the third quarter of 2005
compared to the prior year, due to normal operating cycles.
AIRCRAFT RENTAL EXPENSE increased $697,000, or 17.8%, and $2,597,000, or 24.1%,
for the quarter and nine months ended September 30, 2005, respectively, in
comparison to the quarter and nine months ended September 30, 2004. Incremental
rental expense for 19 leased aircraft added to the Company's fleet, either
during or subsequent to the first nine months of 2004, totaled $1,049,000 and
$2,817,000 in the quarter and nine months ended September 30, 2005,
respectively. The increase for new aircraft was offset in part by refinancing
eleven aircraft at lower lease rates during the nine months ended September 30,
2005.
BAD DEBT EXPENSE increased $8,908,000, or 99.8%, and $10,034,000, or 29.4%, for
the quarter and nine months ended September 30, 2005, in comparison to the prior
year. Bad debt as a percentage of related net flight revenue was 28.3% and 26.1%
for the quarter and nine months ended September 30, 2005, respectively, compared
to 20.3% and 25.5% for the quarter and nine months ended September 30, 2004,
respectively, primarily as the result of a change in payer mix. Flight revenue
is recorded net of Medicare/Medicaid discounts. The total reserve for expected
uncollectible amounts, including contractual discounts and bad debts, decreased
from 49.3% of related gross flight revenue for the third quarter of 2004 to
47.5% for the third quarter of 2005, and from 48.5% for the nine months ended
September 30, 2004, to 46.4% for the nine months ended September 30, 2005. The
Company believes that the improvement in collection rates is primarily the
result of organizational changes within its billing department which provided
for more timely billing and follow up on outstanding accounts. Bad debt expense
related to the Products Division was not significant in either 2005 or 2004.
PRODUCTS DIVISION
SALES OF MEDICAL INTERIORS AND PRODUCTS increased $442,000, or 22.4%, and
$381,000, or 7.1%, for the quarter and nine months ended September 30, 2005,
compared to 2004. In the first quarter of 2005, the Company completed production
of 11 Multi-Mission Medevac Systems for the U. S. Army's HH-60L Black Hawk
helicopter and 19 litter systems for the U.S. Army's Medical Evacuation Vehicle
(MEV). In 2005, the Company also continued production of 13 additional HH60L
units and 21 additional MEV units. Other significant projects in 2005 included
production of a multi-mission interior for a Sikorsky FIREHAWK helicopter for
the Los Angeles County Fire Department and two modular medical interiors for a
commercial customer. Revenue by product line for the quarter and nine months
ended September 30, 2005, respectively, was as follows:
- - $1,235,000 and $2,824,000 - design and manufacture of multi-mission
interiors
- - $546,000 and $1,348,000 - manufacture and installation of modular medical
interiors
- - $634,000 and $1,567,000 - design and manufacture of other aerospace
products
18
Significant projects in 2004 included production of 13 HH-60L units, 40 MEV
units, and a multi-mission interior for a Sikorsky FIREHAWK helicopter for the
Los Angeles County Fire Department. Revenue by product line for the quarter and
nine months ended September 30, 2004, respectively, was as follows:
- - $1,360,000 and $3,381,000 - design and manufacture of multi-mission
interiors
- - $85,000 and $544,000 - manufacture and installation of modular medical
interiors
- - $528,000 and $1,433,000 - design and manufacture of other aerospace
products
COST OF MEDICAL INTERIORS AND PRODUCTS increased $985,000, or 153.7%, and
$1,804,000, or 99.2%, for the quarter and nine months ended September 30, 2005,
respectively, compared to the prior year. The average net margin earned on
projects during 2005 was 30.9% for the third quarter and 28.4% for the
nine-month period compared to 49.6% for the third quarter and 48.1% for the
nine-month period in 2004, primarily due to the change in product mix. The
margin earned on multi-mission interiors is typically higher than the margins
earned on modular medical interiors for commercial customers. Cost of medical
interiors and products also includes certain fixed costs, such as administrative
salaries and facilities rent, which do not vary with volume of sales and which
are absorbed by both projects for external customers and interdivisional
projects.
GENERAL EXPENSES
DEPRECIATION AND AMORTIZATION EXPENSE increased $293,000, or 10.7%, and
$750,000, or 9.2%, for the quarter and nine months ended September 30, 2005,
respectively, compared to 2004, primarily as a result of upgrades to aircraft,
engines, and avionics systems and the purchase of rotable equipment, a new
patient billing software system and related hardware, and office and medical
equipment for the new bases described above.
GENERAL AND ADMINISTRATIVE (G&A) EXPENSES increased $503,000, or 5.8%, and
$2,818,000, or 11.7%, for the quarter and nine months ended September 30, 2005,
respectively, compared to 2004, reflecting an increase in billing and
collections and CBM program administration staff and in pilot training costs to
manage the growth in the Company's operations. G&A expenses include accounting
and finance, billing and collections, human resources, aviation management,
pilot training, dispatch and communications, and CBM program administration. G&A
expenses were 10.1% and 10.9% of revenue for the quarter and nine months ended
September 30, 2005, respectively, compared to 12.5% and 11.8% of revenue for the
quarter and nine months ended September 30, 2004, respectively.
INTEREST EXPENSE decreased $588,000, or 32.4%, and $1,290,000, or 21.7%, in the
quarter and nine months ended September 30, 2005, respectively, compared to
2004, partly as a result of regularly scheduled payments of long-term debt and
decreased borrowings against the Company's line of credit. The average balance
outstanding against the line was approximately $15.0 million and $16.4 million
during the quarter and nine months ended September 30, 2005, respectively,
compared to $16.5 million and $18.5 million during the quarter and nine months
ended September 30, 2004, respectively. In addition, in May 2005, the Company
repaid $23 million in subordinated debt, which had an effective interest rate of
16.2% during 2005, with the proceeds of $20 million in term loans which bore
interest at an effective rate of approximately 6.7% during 2005. The remainder
of the repayment was funded by draws against the line of credit.
LOSS ON EARLY EXTINGUISHMENT OF DEBT for the nine months ended September 30,
2005, totaled $3,104,000 and related to the repayment of $23 million in
subordinated debt in May 2005. The Company wrote off approximately $1,724,000 in
debt origination costs and note discount related to the subordinated debt and
paid a prepayment penalty of $1,380,000 to the holders of the subordinated debt.
INCOME TAX EXPENSE was $3,530,000 and $5,416,000 in the quarter and nine months
ended September 30, 2005, respectively, and $926,000 and $2,220,000 in the
quarter and nine months ended September 30, 2004, respectively, at an effective
rate of approximately 39%.
19
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $60,651,000 as of September 30, 2005,
compared to $48,849,000 at December 31, 2004. The change in working capital
position is primarily attributable to the following:
- - Increase of $14,823,000 in net receivables consistent with increased
revenue for the CBM and HBM divisions and increased net reimbursement for
CBM operations. In addition, days' sales outstanding for CBM operations,
measured by comparing net revenue for the annualized previous 3-month
period to outstanding net accounts receivable, increased from 101 days at
December 31, 2004, to 117 days at September 30, 2005. The increase is
primarily due to a software systems conversion in the billing department
during the third quarter of 2005 which the Company believes slowed the pace
of collections temporarily.
- - Increase of $5,290,000 in current installments of long-term debt, primarily
because of $4.5 million of principal payments due in 2006 for new term
loans into which the Company entered during the second quarter of 2005.
SOURCES AND USES OF CASH
The Company had cash and cash equivalents of $3,066,000 as of September 30,
2005, compared to $2,603,000 at December 31, 2004. Cash generated by operations
in the nine months ended September 30, 2005, totaled $14,181,000 compared to
$13,177,000 in 2004. Receivable balances, net of bad debt expense, increased
$14,823,000 in 2005 compared to $3,096,000 in 2004, reflecting continued growth
in CBM and HBM revenue, an improved net reimbursement rate for CBM operations,
and the increase in days' sales outstanding as described above. Balances for
accounts payable and other accrued liabilities increased $4,327,000 in 2005,
compared to $1,874,000 in 2004, due in part to the timing of the bi-weekly
payroll processing; the nine-month period of 2005 included 19 bi-weekly pay
dates compared to 20 in the nine-month period of 2004.
Cash used by investing activities totaled $3,149,000 in 2005 compared to
$6,714,000 in 2004. Equipment acquisitions in 2005 consisted primarily of
rotable equipment, medical and office equipment for new bases, information
systems hardware and software, and upgrades to aircraft, engines, and avionics
systems. In 2005 the Company received $463,000 in insurance proceeds for an
aircraft destroyed in an accident and sold an aircraft previously classified as
held for sale for $607,000. Equipment acquisitions in 2004 consisted primarily
of medical interior and avionics installations, information systems hardware and
software, and rotable equipment. In 2004 the Company received $1.2 million for
the sale of one of its aircraft which was leased back from the buyer and
approximately $1.3 million from the refund of deposits for the purchase of new
aircraft, primarily through the arrangement of long-term operating lease
financing.
Financing activities used $10,569,000 in 2005 compared to $4,576,000 in 2004. In
2005, the Company used $20 million of term loan proceeds and additional draws
against its line of credit to fund the early repayment of $23 million in
subordinated debt and the related prepayment penalty of $1,380,000. The Company
also paid $431,000 in debt issuance costs, primarily associated with the
amendment to its senior revolving credit facility in May 2005. The Company used
proceeds from new note agreements originated in 2004 to refinance existing debt
with higher interest rates and to fund the acquisition of new software systems
and other capital expenditures. The other primary use of cash in both 2005 and
2004 was regularly scheduled payments of long-term debt and capital lease
obligations.
In May 2005, the Company amended and restated its senior revolving credit
facility and repaid its subordinated debt facility. The amendment provided for,
among other things, $20 million of term loans, an extension of the maturity date
to March 31, 2010, and modifications to the financial covenants. The proceeds
from the term loans, along with additional borrowings under the revolving credit
facility, were used to repay the Company's $23 million of subordinated debt. The
term loans and the revolving loans bear interest, at the Company's option, at
either (i) the higher of the federal funds rate plus 0.50% or the prime rate as
announced by the lenders plus an applicable margin ranging from 0.50% to 1.50%
or (ii) a rate equal to LIBOR plus an applicable margin ranging from 1.75% to
3.75%. Principal payments on the term loans will commence in April 2006 and
total $4.5 million in 2006, $6 million in 2007, $3 million in 2008, $2 million
in 2009, and $4.5 million in 2010. In 2005 the effective interest rate on the
subordinated debt, including amortization of debt origination costs and note
discount, was 16.2%. The term loans bore interest at an effective rate of
approximately 6.7% during 2005. As of September 30, 2005, the Company was in
compliance with the covenants of the senior revolving credit facility.
20
In August 2005, the Company entered into a commitment agreement to purchase six
Eurocopter EC135 helicopters for approximately $23.0 million, with deliveries
scheduled in 2006. In October 2005, the Company also entered into a purchase
commitment for four Eurocopter AS350 helicopters for approximately $6.1 million;
delivery of one aircraft is scheduled for 2005 with the remaining aircraft
expected to be delivered in 2006.
OUTLOOK FOR 2005
The statements contained in this Outlook are based on current expectations.
These statements are forward looking, and actual results may differ materially.
The Company undertakes no obligation to update any forward-looking statements.
Community-Based Model
In the first quarter of 2005, the Company purchased the operations of a
hospital-based program which had been served by another vendor in northern
California and expanded it from one base to two. The Company also discontinued
operations at a base in Missouri due to low flight volume. During the third
quarter of 2005, the Company began operations at two new bases and expects to
open one new base in the southeast region during the fourth quarter. CBM flight
volume at all other locations is expected to be consistent with historical
levels during the remainder of 2005, subject to seasonal, weather-related
fluctuations.
Effective October 1, 2005, the Company increased prices for its CBM operations
an average of 5%.
Hospital-Based Model
In 2005, the Company expanded five contracts in Utah, Minnesota, Virginia, West
Virginia, and Oklahoma to additional satellite bases. The Company expects
similar expansions under one other contract during the fourth quarter of 2005.
Twelve hospital contracts were due for renewal in 2005. All have been renewed
for terms ranging from one to five years. During the fourth quarter of 2005, the
Company suspended operations under its contract in Puerto Rico pending
settlement of outstanding receivable balances; resumption of operations is still
under negotiation with the customer. The Company expects flight activity for
continuing hospital contracts to remain consistent with historical levels for
the remainder of 2005.
Products Division
In the second quarter of 2005, the Company received an order for eleven
additional HH-60L units. As of September 30, 2005, the Company was continuing
the production of 21 MEV units and thirteen HH-60L units, including the eleven
units ordered in the second quarter, and the installation of an avionics system
in a helicopter for an HBM customer. Remaining revenue for all contracts in
process as of September 30, 2005, is estimated at $4.1 million.
The current U.S. Army Aviation Modernization Plan defines a requirement for 180
HH-60L Multi-Mission Medevac units in total over an unspecified number of years.
The Company has already completed 26 HH-60L units under the program, in addition
to the thirteen currently under contract. The U.S. Army has also forecasted a
requirement for a total of 119 MEV units over four years; the Company has
previously delivered 82 units, in addition to the 21 units currently under
contract. There is no assurance that orders for additional units will be
received in future periods.
All Segments
The Company implemented a new software system for patient billing in July 2005
and expects to implement new software for inventory tracking in 2006.
There can be no assurance that the Company will continue to maintain flight
volume or current levels of collections on receivables for CBM operations, renew
operating agreements for its HBM operations, or generate new profitable
contracts for the Products Division. Based on the anticipated level of HBM and
CBM flight activity and the projects in process for the Products Division, the
Company expects to generate sufficient cash flow to meet its operational needs
throughout the remainder of 2005. The Company also had approximately $18,020,000
in borrowing capacity available under its revolving credit facility as of
September 30, 2005.
21
RISK FACTORS
Actual results achieved by the Company may differ materially from those
described in forward-looking statements as a result of various factors,
including but not limited to, those discussed above in "Outlook for 2005" and
those described below.
- - Flight volume - All CBM revenue and approximately 38% of HBM revenue is
dependent upon flight volume. Approximately 38% of the Company's total
operating expenses also vary with the number of hours flown. Poor
visibility, high winds, and heavy precipitation can affect the safe
operation of aircraft and therefore result in a reduced number of flight
hours due to the inability to fly during these conditions. Prolonged
periods of adverse weather conditions could have an adverse impact on the
Company's operating results. Typically, the months from November through
February tend to have lower flight volume due to weather conditions and
other factors, resulting in lower CBM operating revenue during these
months. Flight volume for CBM operations can also be affected by the
distribution of calls among competitors by local government agencies and
the entrance of new competitors into a market.
- - Collection rates - The Company responds to calls for air medical transport
without pre-screening the creditworthiness of the patient. The CBM division
invoices patients and their insurers directly for services rendered and
recognizes revenue net of estimated contractual allowances. The level of
bad debt expense is driven by collection rates on these accounts. Changes
in estimated contractual allowances and bad debts are recognized based on
actual collections in subsequent periods. Collectibility is affected by the
number of uninsured or indigent patients transported and is, therefore,
primarily dependent upon the health of the U.S. economy. A significant or
sustained downturn in the U.S. economy could have an adverse impact on the
Company's bad debt expense.
- - Highly leveraged balance sheet - The Company is obligated under debt
facilities providing for up to approximately $92.9 million of indebtedness,
of which approximately $69.2 million was outstanding (net of $3.1 million
of cash) at September 30, 2005. If the Company fails to meet its payment
obligations or otherwise defaults under the agreements governing
indebtedness, the lenders under those agreements will have the right to
accelerate the indebtedness and exercise other rights and remedies against
the Company. These rights and remedies include the rights to repossess and
foreclose upon the assets that serve as collateral, initiate judicial
foreclosure against the Company, petition a court to appoint a receiver for
the Company, and initiate involuntary bankruptcy proceedings against the
Company. If lenders exercise their rights and remedies, the Company's
assets may not be sufficient to repay outstanding indebtedness, and there
may be no assets remaining after payment of indebtedness to provide a
return on common stock.
- - Restrictive debt covenants - The Company's senior revolving credit facility
contains restrictive financial and operating covenants, including
restrictions on the Company's ability to incur additional indebtedness, to
exceed certain annual capital expenditure limits, and to engage in various
corporate transactions such as mergers, acquisitions, asset sales and the
payment of cash dividends. These covenants may restrict future growth
through the limitation on capital expenditures and acquisitions, and may
adversely impact the Company's ability to implement its business plan.
Failure to comply with the covenants defined in the agreement or to
maintain the required financial ratios could result in an event of default
and accelerate payment of the principal balances due under the senior
revolving credit facility. Given factors beyond the Company's control, such
as interruptions in operations from unusual weather patterns not included
in current projections, there can be no assurance that the Company will be
able to remain in compliance with financial covenants in the future, or
that, in the event of non-compliance, the Company will be able to obtain
waivers from the lenders, or that to obtain such waivers, the Company will
not be required to pay lenders significant cash or equity compensation.
- - Employee unionization - In September 2003, the Company's pilots voted to be
represented by a collective bargaining unit. Negotiations on a collective
bargaining agreement began in early 2004 and consensus has been reached on
a majority of the non-economic issues under consideration. However, the
economic demands of the union have continued to be significantly higher
than the Company's offers. In November 2005, the Company provided a
settlement offer to the union which included changes to base salary and
overtime pay and to the Company's contribution to the defined contribution
retirement plan (401k plan). The estimated impact of the proposed change in
base salary is $2.8 million in the year of implementation. Because the
impact of changes to overtime pay and to the 401k plan contributions is
dependent upon staffing levels and employee participation in the 401k plan,
the effect on
22
the Company's financial statements cannot presently be fully quantified.
The Company has also not yet determined the extent to which, if any, the
impact of the settlement offer may be offset by price increases. There can
be no assurance that the Company's offer will be accepted by the union or
that the Company will not be subject to a work stoppage if the parties are
unable to come to an agreement. Other employee groups may also elect to be
represented by unions in the future.
- - Governmental regulation - The air medical transportation services and
products industry is subject to extensive regulation by governmental
agencies, including the Federal Aviation Administration, which impose
significant compliance costs on the Company. In addition, reimbursement
rates for air ambulance services established by governmental programs such
as Medicare directly affect CBM revenue and indirectly affect HBM revenue
from customers. Changes in laws or regulations, such as the minimum weather
standards for flight acceptance which are expected to change in 2006, or
reimbursement rates could have a material adverse impact on the Company's
cost of operations or revenue from flight operations. In January 2005 the
Company experienced two fatal accidents which are currently under
investigation by the National Transportation Safety Board. The outcome of
these investigations and the potential impact on the Company's operations
cannot yet be ascertained.
- - Compliance with corporate governance and public disclosure regulations -
New laws, regulations, and standards relating to corporate governance and
public disclosure-including the Sarbanes-Oxley Act of 2002, new SEC
regulations, and NASDAQ National Market rules-are subject to varying
interpretations in many cases due to lack of specificity. Their application
may evolve over time as new guidance is provided by regulatory and
governing bodies, which may result in continuing uncertainty regarding
compliance matters and higher costs necessitated by ongoing revisions to
disclosure and governance practices. The Company's efforts to maintain high
standards of corporate governance and public disclosure in compliance with
evolving laws and regulations have resulted in, and are likely to continue
to result in, increased general and administrative expenses and a diversion
of management's time and attention from revenue-generating activities to
compliance activities. In particular, compliance with Section 404 of the
Sarbanes-Oxley Act of 2002, which requires the Company to include
management and auditor reports on internal controls as part of its annual
report, has required commitment of significant financial and managerial
resources. In addition, board members, the chief executive officer, and
chief financial officer could face an increased risk of personal liability
in connection with the performance of their duties. As a result, the
Company may have difficulty attracting and retaining qualified board
members and executive officers. If efforts to comply with new or changed
laws, regulations, and standards differ from the activities intended by
regulatory or governing bodies due to ambiguities related to practice, the
Company's reputation may be harmed.
- - Internal controls - The Company is required by Section 404 of the
Sarbanes-Oxley Act of 2002 to include management and auditor reports on
internal controls as part of its annual report. Management concluded that
internal control over financial reporting was effective at December 31,
2004, and the Company's independent auditors attested to that conclusion.
There can be no assurance that material weaknesses in internal controls
over financial reporting will not be discovered in the future or that the
Company and its independent auditors will be able to conclude that internal
control over financial reporting is effective in the future. Although it is
unclear what impact failure to comply fully with Section 404 or the
discovery of a material weakness in internal controls over financial
reporting would have on the Company, it may subject the Company to
regulatory scrutiny and result in additional expenditures to meet the
requirements, a reduced ability to obtain financing, or a loss of investor
confidence in the accuracy of the Company's financial reports.
- - Competition - HBM operations face significant competition from several
national and regional air medical transportation providers for contracts
with hospitals and other healthcare institutions. In addition to the
national and regional providers, CBM operations also face competition from
smaller regional carriers and alternative air ambulance providers such as
sheriff departments. Operators generally compete on the basis of price,
safety record, accident prevention and training, and the medical capability
of the aircraft. The Company's competition in the aircraft interior design
and manufacturing industry comes primarily from three companies based in
the United States and three in Europe. Competition is based mainly on
product availability, price, and product features, such as configuration
and weight. There can be no assurance that the Company will be able to
continue to compete successfully for new or renewing contracts in the
future.
23
- - Fuel costs - Fuel accounted for 2.4% of total operating expenses for the
nine months ended September 30, 2005. Both the cost and availability of
fuel are influenced by many economic and political factors and events
occurring in oil-producing countries throughout the world, and fuel costs
fluctuate widely. Recently the price per barrel of oil has been at an
all-time high. The Company cannot predict the future cost and availability
of fuel. The unavailability of adequate fuel supplies could have an adverse
effect on the Company's cost of operations and profitability. Generally,
the Company's HBM customers pay for all fuel consumed in medical flights.
However, the Company's ability to pass on increased fuel costs for CBM
operations may be limited by economic and competitive conditions and by
reimbursement rates established by Medicare, Medicaid, and insurance
providers. The Company does not currently have any agreements in place to
hedge its fuel costs.
- - Aviation industry hazards and insurance limitations - Hazards are inherent
in the aviation industry and may result in loss of life and property,
thereby exposing the Company to potentially substantial liability claims
arising out of the operation of aircraft. The Company may also be sued in
connection with medical malpractice claims arising from events occurring
during a medical flight. Under HBM operating agreements, hospital customers
have agreed to indemnify the Company against liability arising out of
medical malpractice claims and to maintain insurance covering such
liability, but there can be no assurance that a hospital will not challenge
the indemnification rights or will have sufficient assets or insurance
coverage for full indemnity. In CBM operations, Company personnel perform
medical procedures on transported patients, which may expose the Company to
significant direct legal exposure to medical malpractice claims. The
Company maintains general liability aviation insurance, aviation product
liability coverage, and medical malpractice insurance, and believes that
the level of coverage is customary in the industry and adequate to protect
against claims. However, there can be no assurance that it will be
sufficient to cover potential claims or that present levels of coverage
will be available in the future at reasonable cost. A limited number of
hull and liability insurance underwriters provide coverage for air medical
operators. A significant downturn in insurance market conditions could have
a material adverse effect on the Company's cost of operations.
Approximately 42% of any increases in hull and liability insurance may be
passed through to the Company's HBM customers according to contract terms.
In addition, the loss of any aircraft as a result of accidents could cause
both significant adverse publicity and interruption of air medical services
to client hospitals, which could adversely affect the Company's operating
results and relationship with such hospitals. The January accidents did not
have a material impact on the Company's hull and liability insurance rates
as renewed in July 2005. However, in the nine months ended September 30,
2005, the Company recorded an increase in expense of $790,000 for the
self-insured portion of workers compensation premiums as a result of the
accidents.
- - Foreign ownership - Federal law requires that United States air carriers be
citizens of the United States. For a corporation to qualify as a United
States citizen, the president and at least two-thirds of the directors and
other managing officers of the corporation must be United States citizens
and at least 75% of the voting interest of the corporation must be owned or
controlled by United States citizens. If the Company is unable to satisfy
these requirements, operating authority from the Department of
Transportation may be revoked. Furthermore, under certain loan agreements,
an event of default occurs if less than 80% of the voting interest is owned
or controlled by United States citizens. As of September 30, 2005, the
Company was aware of one foreign person who, according to public securities
filings, is believed to hold approximately 9.6% of outstanding Common
Stock. Because the Company is unable to control the transfer of its stock,
it is unable to assure that it can remain in compliance with these
requirements in the future.
- - Dependence on third party suppliers - The Company currently obtains a
substantial portion of its helicopter spare parts and components from Bell
Helicopter, Inc., (Bell) and American Eurocopter Corporation (AEC), because
its fleet is composed primarily of Bell and AEC aircraft, and maintains
supply arrangements with other parties for its engine and related dynamic
components. Based upon the manufacturing capabilities and industry contacts
of Bell, AEC, and other suppliers, the Company believes it will not be
subject to material interruptions or delays in obtaining aircraft parts and
components but does not have an alternative source of supply for Bell, AEC,
and certain other aircraft parts. Failure or significant delay by these
vendors in providing necessary parts could, in the absence of alternative
sources of supply, have a material adverse effect on the Company. Because
of its dependence upon Bell and AEC for helicopter parts, the Company may
also be subject to adverse impacts from unusually high price increases
which are greater than overall inflationary trends. Increases in the
Company's monthly and hourly flight fees billed to its HBM customers may be
limited to changes in the consumer price index. As a result, an unusually
high increase in the price of parts may not be fully passed on to the
Company's HBM customers. The ability to pass on price increases for CBM
operations may be limited by reimbursement rates established by Medicare,
Medicaid, and insurance providers and by other market considerations.
24
- - Employee recruitment and retention - An important aspect of the Company's
operations is the ability to hire and retain employees who have advanced
aviation, nursing, and other technical skills. In addition, hospital
contracts typically contain minimum certification requirements for pilots
and mechanics. Employees who meet these standards are in great demand and
are likely to remain a limited resource in the foreseeable future. If the
Company is unable to recruit and retain a sufficient number of these
employees, the ability to maintain and grow the business could be
negatively impacted.
- - Department of Defense funding - Several of the projects which have
historically been significant sources of revenue for the Products Division,
including HH-60L and MEV systems, are dependent upon Department of Defense
funding. Failure of the U.S. Congress to approve funding for the production
of additional HH-60L or MEV units could have a material adverse impact on
Products Division revenue.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States. The
preparation of these financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period.
On an on-going basis, management evaluates its estimates and judgments,
including those related to revenue recognition, uncollectible receivables,
deferred income taxes, and depreciation and residual values. Management bases
its estimates and judgments on historical experience and on various other
factors that are believed to be reasonable under the circumstances, the results
of which form the basis for making judgments about the carrying values of assets
and liabilities that are not readily apparent from other sources. Actual results
may differ from these estimates under different assumptions or conditions.
Management believes the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements.
Revenue Recognition
Fixed flight fee revenue under the Company's operating agreements with hospitals
is recognized monthly over the terms of the agreements. Flight revenue relating
to patient transports is recognized upon completion of the services. Revenue and
accounts receivable are recorded net of estimated contractual allowances under
agreements with third-party payers. Estimates of contractual allowances are
initially determined based on historical discount percentages for Medicare and
Medicaid patients and adjusted periodically based on actual discounts. If actual
discounts realized are more or less than those projected by management,
adjustments to contractual allowances may be required. Based on related gross
flight revenue for the nine months ended September 30, 2005, a change of 100
basis points in the percentage of estimated contractual discounts would have
resulted in a change of approximately $2,337,000 in flight revenue.
Revenue related to fixed fee medical interior and products contracts is recorded
as costs are incurred using the percentage of completion method of accounting.
The Company estimates the percentage of completion based on costs incurred to
date as a percentage of an estimate of the total costs to complete the project.
Losses on contracts in process are recognized when determined. If total costs to
complete a project are greater or less than estimated, the gross margin on the
project may be greater or less than originally recorded under the percentage of
completion method.
Uncollectible Receivables
The Company responds to calls for air medical transports without pre-screening
the credit worthiness of the patient. Uncollectible trade receivables are
charged to operations using the allowance method. Estimates of uncollectible
receivables are determined monthly based on historical collection rates and
adjusted monthly thereafter based on actual collections. If actual future
collections are more or less than those projected by management, adjustments to
allowances for uncollectible accounts may be required. There can be no guarantee
that the Company will continue to experience the same collection rates that it
has in the past. Based on related net flight revenue for the nine months ended
September 30, 2005, a change of 100 basis points in the percentage of estimated
uncollectible accounts would have resulted in a change of approximately
$1,694,000 in bad debt expense.
25
Deferred Income Taxes
In preparation of the consolidated financial statements, the Company is required
to estimate income taxes in each of the jurisdictions in which it operates. This
process involves estimating actual current tax exposure together with assessing
temporary differences resulting from differing treatment of items, such as
depreciable assets and bad debt reserves, for tax and accounting purposes. These
differences result in deferred tax assets and liabilities, which are included in
the consolidated balance sheets. The Company then assesses the likelihood that
deferred tax assets will be recoverable from future taxable income and records a
valuation allowance for those amounts it believes are not likely to be realized.
Establishing or increasing a valuation allowance in a period increases income
tax expense. The Company considers estimated future taxable income, tax planning
strategies, and the expected timing of reversals of existing temporary
differences in assessing the need for a valuation allowance against deferred tax
assets. In the event the Company were to determine that it would not be able to
realize all or part of its net deferred tax assets in the future, an adjustment
to the valuation allowance would be charged to income in the period such
determination was made. Likewise, should the Company determine that it would be
able to realize its deferred tax assets in the future in excess of its net
recorded amount, an adjustment to the valuation allowance would increase income
in the period such determination was made.
Depreciation and Residual Values
In accounting for long-lived assets, the Company makes estimates about the
expected useful lives, projected residual values and the potential for
impairment. Estimates of useful lives and residual values of aircraft are based
upon actual industry experience with the same or similar aircraft types and
anticipated utilization of the aircraft. Changing market prices of new and used
aircraft, government regulations and changes in the Company's maintenance
program or operations could result in changes to these estimates. Long-lived
assets are evaluated for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability of long-lived assets is measured by a comparison of the carrying
amount of an asset to future net cash flows expected to be generated by the
asset.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the potential loss arising from adverse changes in market rates
and prices, such as foreign currency exchange and interest rates. All of the
Company's product sales and related receivables are payable in U.S. dollars. The
Company is subject to interest rate risk on its debt obligations and notes
receivable, most of which have fixed interest rates, except $14,366,000
outstanding against the line of credit and $21,976,000 in term loans and notes
payable. Based on the amounts outstanding at September 30, 2005, the annual
impact of a change of 100 basis points in interest rates would be approximately
$363,000. Interest rates on these instruments approximate current market rates
as of September 30, 2005.
Periodically the Company enters into interest rate risk hedges to minimize
exposure to the effect of an increase in interest rates. As of September 30,
2005, the Company was party to one interest rate swap agreement. The swap
agreement provides that the Company will pay a 3.62% fixed interest rate on
$877,000 of notional principal and receive a floating interest rate (LIBOR plus
2.50%) on the same amount of notional principal from the counterparty.
26
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's reports filed
or submitted to the Securities and Exchange Commission under the Securities
Exchange Act of 1934, as amended, is recorded, processed, summarized and
reported within the time periods specified by the Commission's rules and forms,
and that information is accumulated and communicated to management, including
the principal executive and financial officers (referred to in this report as
the Certifying Officers), as appropriate to allow timely decisions regarding
required disclosure. Management, under the supervision and with the
participation of the Certifying Officers, evaluated the effectiveness of
disclosure controls and procedures as of September 30, 2005, pursuant to Rule
13a-15(b) under the Exchange Act. Based on that evaluation, the Certifying
Officers have concluded that, as of September 30, 2005, the Company's disclosure
controls and procedures were effective.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There were no significant changes in the Company's internal control over
financial reporting that occurred during the most recently completed fiscal
quarter that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
In the third quarter of 2005, the Company upgraded its hardware and software
systems for patient billing.
27
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not Applicable
ITEM 2. CHANGES IN SECURITIES
Not Applicable
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 2005 Annual Meeting of Stockholders was held on August 3, 2005. At
the meeting, Messrs. Samuel H. Gray, Morad Tahbaz, and Aaron D. Todd
were elected to Class II directorships. Voting results were as
follows:
Total Vote
Total Vote For Withheld From
Each Director Each Director
-------------- -------------
Samuel H. Gray 8,778,232 976,570
Morad Tahbaz 8,211,324 1,543,478
Aaron D. Todd 8,806,830 947,972
Following the meeting, George W. Belsey; Ralph J. Bernstein; David
Kikumoto; Maj. Gen. Carl H. McNair, Jr. (Ret.); Lowell D. Miller, Ph.
D.; and Paul Tate continued to serve as directors.
Stockholders rejected the 2005 Equity Compensation Plan which had been
adopted by the Board of Directors in June 2005, subject to stockholder
approval. Voting results were as follows:
For Against Abstain/Broker Non-Vote
--------- --------- -----------------------
2,290,563 2,530,411 4,937,645
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6. EXHIBITS
10.1 Aircraft purchase agreement, dated August 10, 2005, between Air
Methods Corporation and American Eurocopter, LLC
10.2 Aircraft purchase agreement, dated August 10, 2005, between Air
Methods Corporation and American Eurocopter, LLC
31.1 Chief Executive Officer Certification adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
31.2 Chief Financial Officer Certification adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002
32 Certification adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
28
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AIR METHODS CORPORATION
Date: November 9, 2005 By \s\ Aaron D. Todd
--------------------------------------
Aaron D. Todd
Chief Executive Officer
(Principal Executive Officer)
Date: November 9, 2005 By \s\ Trent J. Carman
--------------------------------------
Trent J. Carman
Chief Financial Officer
(Principal Financial Officer)
Date: November 9, 2005 By \s\ Sharon J. Keck
--------------------------------------
Sharon J. Keck
Chief Accounting Officer
(Principal Accounting Officer)
29