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, 2004
-----------------------------------
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 No X
--- ---
The number of shares of Common Stock, par value $.06, outstanding as of October
29, 2004, was 10,943,340.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - September 30, 2004
and December 31, 2003 1
Consolidated Statements of Operations for the three and nine
months ended September 30, 2004 and 2003 3
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2004 and 2003 5
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 24
Item 4. Controls and Procedures 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities 25
Item 3. Defaults upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURES 26
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,
2004 2003
------------------------------
Assets
- ------
Current assets:
Cash and cash equivalents $ 7,461 5,574
Current installments of notes receivable 60 58
Receivables:
Trade 96,977 91,509
Less allowance for doubtful accounts (32,396) (30,301)
------------------------------
64,581 61,208
Other 3,143 3,420
------------------------------
Total receivables 67,724 64,628
------------------------------
Inventories 8,879 9,143
Work-in-process on medical interiors and products contracts 575 145
Assets held for sale 5,245 431
Costs and estimated earnings in excess of billings on
uncompleted contracts 2,315 2,249
Deferred tax asset -- 105
Prepaid expenses and other 2,491 1,653
------------------------------
Total current assets 94,750 83,986
------------------------------
Equipment and leasehold improvements:
Land 190 190
Flight and ground support equipment 132,944 149,568
Furniture and office equipment 11,195 10,436
------------------------------
144,329 160,194
Less accumulated depreciation and amortization (50,434) (47,117)
------------------------------
Net equipment and leasehold improvements 93,895 113,077
------------------------------
Goodwill 6,485 6,485
Notes receivable, less current installments 813 1,426
Other assets, net of accumulated amortization of $1,897 and $1,347
at September 30, 2004 and December 31, 2003, respectively 9,769 10,675
------------------------------
Total assets $ 205,712 215,649
==============================
(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,
2004 2003
-----------------------------
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities:
Notes payable $ 4,748 --
Current installments of long-term debt 5,897 6,110
Current installments of obligations under capital leases 2,517 2,886
Accounts payable 6,135 6,097
Accrued overhaul and parts replacement costs -- 7,702
Deferred revenue 3,845 2,898
Billings in excess of costs and estimated earnings on
uncompleted contracts 744 174
Deferred income taxes 2,850 --
Accrued wages and compensated absences 5,194 6,015
Other accrued liabilities 12,316 8,422
-----------------------------
Total current liabilities 44,246 40,304
Long-term debt, less current installments 72,786 76,680
Obligations under capital leases, less current installments 33 251
Accrued overhaul and parts replacement costs -- 26,107
Deferred income taxes 9,920 5,151
Other liabilities 5,700 6,468
-----------------------------
Total liabilities 132,685 154,961
-----------------------------
Stockholders' equity (note 4):
Preferred stock, $1 par value. Authorized 5,000,000 shares,
none issued --
Common stock, $.06 par value. Authorized 16,000,000 shares;
issued 10,932,171 and 10,817,594 shares at September 30, 2004
and December 31, 2003, respectively 656 649
Additional paid-in capital 64,724 64,413
Retained earnings (accumulated deficit) 7,647 (4,374)
Treasury stock at par, 4,040 common shares at
September 30, 2004 -- --
-----------------------------
Total stockholders' equity 73,027 60,688
-----------------------------
Total liabilities and stockholders' equity $ 205,712 215,649
=============================
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,
----------------------------------------------
2004 2003 2004 2003
----------------------------------------------
Revenue:
Flight revenue $ 66,958 65,023 199,396 171,381
Sales of medical interiors and products 1,973 1,702 5,358 4,614
Parts and maintenance sales and services 18 234 84 726
Gain on disposition of assets, net -- 18 -- --
----------------------------------------------
68,949 66,977 204,838 176,721
----------------------------------------------
Operating expenses:
Flight centers 25,421 22,844 73,980 64,241
Aircraft operations 16,081 14,475 44,688 41,759
Aircraft rental 3,911 3,251 10,773 9,111
Medical interiors and products sold 641 1,070 1,818 3,573
Cost of parts and maintenance sales and services 19 251 103 742
Depreciation and amortization 2,729 2,905 8,140 8,461
Bad debt expense 8,926 10,158 34,147 22,060
Loss on disposition of assets, net 8 -- 34 8
General and administrative 7,201 5,444 20,318 15,668
----------------------------------------------
64,937 60,398 194,001 165,623
----------------------------------------------
Operating income 4,012 6,579 10,837 11,098
Other income (expense):
Interest expense (1,816) (2,218) (5,936) (6,152)
Interest income 4 80 13 86
Other, net 178 (28) 732 678
----------------------------------------------
Income before income tax expense and cumulative effect
of change in accounting principle 2,378 4,413 5,646 5,710
Income tax expense 926 1,721 2,220 2,227
----------------------------------------------
Income before cumulative effect of change in accounting
principle 1,452 2,692 3,426 3,483
Cumulative effect of change in method of accounting for
maintenance costs, net of income taxes (note 2) -- -- 8,595 --
----------------------------------------------
Net income $ 1,452 2,692 12,021 3,483
==============================================
(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,
2004 2003 2004 2003
---------------------------------------------
Basic income per common share (note 3):
Income before cumulative effect of change in accounting
principle $ .13 .28 .32 .36
Cumulative effect of change in method of accounting for
maintenance costs, net of income taxes -- -- .79 --
---------------------------------------------
Net income $ .13 .28 1.11 .36
=============================================
Diluted income per common share (note 3):
Income before cumulative effect of change in accounting
principle $ .13 .27 .30 .35
Cumulative effect of change in method of accounting for
maintenance costs, net of income taxes -- -- .76 --
---------------------------------------------
Net income $ .13 .27 1.06 .35
=============================================
Weighted average number of common shares outstanding -
basic 10,921,369 9,577,916 10,873,783 9,554,040
=============================================
Weighted average number of common shares outstanding -
diluted 11,296,854 9,974,973 11,272,876 9,926,561
=============================================
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,
------------------------------------
2004 2003
------------------------------------
Cash flows from operating activities:
Net income $ 12,021 3,483
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization expense 8,140 8,461
Vesting of common stock options issued for services -- 75
Bad debt expense 34,147 22,060
Deferred income tax expense 2,229 2,087
Loss on retirement and sale of equipment, net 34 8
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 (715) 525
Increase in receivables (37,243) (36,764)
Decrease in inventories 264 1,264
Increase in work-in-process on medical interiors and costs in excess of
billings (496) (281)
Increase (decrease) in accounts payable and other accrued liabilities 2,652 (3,521)
Increase (decrease) in deferred revenue, billings in excess of costs, and
other liabilities 739 (769)
Increase in accrued overhaul and parts replacement costs -- 3,583
------------------------------------
Net cash provided by operating activities 13,177 211
------------------------------------
Cash flows from investing activities:
Acquisition of equipment and leasehold improvements (9,378) (2,884)
Proceeds from disposition and sale of equipment 1,217 10
Decrease in notes receivable and other assets 1,012 620
------------------------------------
Net cash used by investing activities (7,149) (2,254)
------------------------------------
(Continued)
5
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------
2004 2003
------------------------------------
Cash flows from financing activities:
Proceeds from issuance of common stock, net $ 771 562
Payments for purchases of common stock (453) (166)
Net borrowings (repayments) under line of credit (86) 6,261
Proceeds from issuance of long-term debt 8,531 2,490
Payments of long-term debt (12,317) (4,757)
Payments of capital lease obligations (587) (575)
------------------------------------
Net cash provided (used) by financing activities (4,141) 3,815
------------------------------------
Increase in cash and cash equivalents 1,887 1,772
Cash and cash equivalents at beginning of period 5,574 1,410
------------------------------------
Cash and cash equivalents at end of period $ 7,461 3,182
====================================
Non-cash investing and financing activities:
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 is held for sale
as of September 30, 2004.
In the nine months ended September 30, 2003, the Company sold a hangar in
exchange for a note receivable totaling $315.
In the nine months ended September 30, 2003, the Company settled a note payable
totaling $1,121 in exchange for the aircraft securing the debt. The Company also
entered into a note payable of $516 to finance insurance policies.
In the nine months ended September 30, 2003, the Company made adjustments to the
purchase price allocation related to the acquisition of Rocky Mountain Holdings,
LLC (RMH), which increased goodwill by $1,341, increased accounts receivable by
$1,070, decreased inventory by $1,268, decreased work in process by $33,
decreased prepaid expenses by $59, decreased equipment by $342, decreased other
assets by $27, increased accounts payable and other accrued liabilities by
$1,647, increased deferred revenue by $66, and decreased other liabilities by
$1,031.
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 fiscal year
ended December 31, 2003.
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 aircraft overhaul
costs. Actual results could differ from those estimates.
The Company operates under an FAA-approved continuous inspection and
maintenance program. The Company accounts for maintenance activities on the
direct expense method. Under this method, commencing January 1, 2004, all
maintenance costs are recognized as expense as costs are incurred. Prior to
January 1, 2004, the Company accrued for major engine and airframe
component overhaul costs based on usage of the aircraft component over the
period between overhauls or replacements in advance of performing the
maintenance services. (See Note 2).
Certain prior period amounts have been reclassified to conform with the
2004 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).
7
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(3) 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:
2004 2003
---------- ---------
FOR QUARTER ENDED SEPTEMBER 30:
Weighted average number of common shares outstanding - basic 10,921,369 9,577,916
Dilutive effect of:
Common stock options 68,201 105,490
Common stock warrants 307,284 291,567
---------------------
Weighted average number of common shares outstanding - diluted 11,296,854 9,974,973
=====================
FOR NINE MONTHS ENDED SEPTEMBER 30:
Weighted average number of common shares outstanding - basic 10,873,783 9,554,040
Dilutive effect of:
Common stock options 90,704 89,692
Common stock warrants 308,389 282,829
---------------------
Weighted average number of common shares outstanding - diluted 11,272,876 9,926,561
=====================
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. Common stock
options totaling 187,500 were not included in the diluted income per share
calculation for the quarter and nine months ended September 30, 2003,
because their effect would have been anti-dilutive.
(4) STOCKHOLDERS' EQUITY
---------------------
Changes in stockholders' equity for the nine months ended September 30,
2004, consisted of the following (amounts in thousands except share
amounts):
Shares
Outstanding Amount
----------------------
Balances at January 1, 2004 10,817,594 $60,688
Issuance of common shares for options exercised 160,201 771
Purchase of treasury shares (49,664) (453)
Net income -- 12,021
----------------------
Balances at September 30, 2004 10,928,131 $73,027
======================
Treasury shares of 45,624 were retired during the nine months ended
September 30, 2004.
8
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(5) 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
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,
2004 2003 2004 2003
------------------------------------------
Net income before cumulative effect of change in
accounting principle:
As reported $ 1,452 2,692 3,426 3,483
Pro forma 1,379 2,629 3,208 3,308
Net income:
As reported $ 1,452 2,692 12,021 3,483
Pro forma 1,379 2,629 11,803 3,308
Basic income per share before cumulative effect
of change in accounting principle:
As reported $ .13 .28 .32 .36
Pro forma .13 .27 .30 .35
Basic income per share:
As reported $ .13 .28 1.11 .36
Pro forma .13 .27 1.09 .35
Diluted income per share before cumulative effect
of change in accounting principle:
As reported $ .13 .27 .30 .35
Pro forma .12 .26 .28 .33
Diluted income per share:
As reported $ .13 .27 1.06 .35
Pro forma .12 .26 1.05 .33
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 2004 and 2003, respectively: dividend yield of
0%; expected volatility of 32%; and expected life of 4 years and 3 years; and
risk-free interest rates of 3.3% and 1.7% The weighted average fair value of
options granted during the nine months ended September 30, 2004 and 2003, was
$2.94 and $1.96, respectively.
9
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(6) 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 throughout the U.S. 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
- -------------------------------------------------------------------------------------------------------
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 29,884 20,220 2,282 2,278 (1,560) 53,104
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
Interest income -- -- -- (4) -- (4)
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
=====================================================================
2003
External revenue $41,971 23,065 1,702 221 -- 66,959
Intersegment revenue -- -- 2,392 -- (2,392) --
---------------------------------------------------------------------
Total revenue 41,971 23,065 4,094 221 (2,392) 66,959
---------------------------------------------------------------------
Operating expenses 25,645 18,560 2,830 2,048 (1,738) 47,345
Depreciation & amortization 1,261 1,167 39 438 -- 2,905
Bad debt expense 10,158 -- -- -- -- 10,158
Interest expense 1,023 1,127 -- 68 -- 2,218
Interest income -- (76) -- (4) -- (80)
Income tax expense -- -- -- 1,721 -- 1,721
---------------------------------------------------------------------
Segment net income (loss) $ 3,884 2,287 1,225 (4,050) (654) 2,692
=====================================================================
Total assets $70,930 N/A N/A 135,267 (2,164) 204,033
=====================================================================
10
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(6) BUSINESS SEGMENT INFORMATION, CONTINUED
---------------------------------------
Products Corporate Intersegment
FOR NINE MONTHS ENDED SEPTEMBER 30: CBM HBM Division Activities Eliminations Consolidated
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 85,620 57,083 7,026 6,208 (4,955) 150,982
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
Interest income -- -- -- (13) -- (13)
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
=======================================================================
2003
External revenue $105,290 66,172 4,614 645 -- 176,721
Intersegment revenue -- -- 4,476 -- (4,476) --
-----------------------------------------------------------------------
Total revenue 105,290 66,172 9,090 645 (4,476) 176,721
-----------------------------------------------------------------------
Operating expenses 69,656 54,966 7,188 6,092 (3,478) 134,424
Depreciation & amortization 3,562 3,469 128 1,302 -- 8,461
Bad debt expense 22,060 -- -- -- -- 22,060
Interest expense 2,948 3,072 -- 132 -- 6,152
Interest income (1) (78) -- (7) -- (86)
Income tax expense -- -- -- 2,227 -- 2,227
-----------------------------------------------------------------------
Segment net income (loss) $ 7,065 4,743 1,774 (9,101) (998) 3,483
=======================================================================
Total assets $ 70,930 N/A N/A 135,267 (2,164) 204,033
=======================================================================
11
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; flight volume of CBM operations;
collection rates for patient transports; continuation and/or renewal of HBM
contracts; acquisition of new and profitable Products Division contracts; 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, 2004, the CBM Division
generated 65% of the Company's total revenue, increasing from 60% in the
nine months ended September 30, 2003.
- - 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 65% of total contract
revenue) and hourly flight fees (approximately 35% of total contract
revenue) billed to hospital customers. In the nine months ended September
30, 2004, the HBM Division generated 32% of the Company's total revenue,
decreasing from 37% in 2003.
- - Products Division - designs, manufactures, and installs aircraft medical
interiors and other aerospace and medical transport products for domestic
and international customers. In 2004 the Products Division generated 3% of
the Company's total revenue, unchanged from 2003.
See Note 6 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 35% of HBM revenue. By contrast,
approximately 64% 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. Total patient transports for CBM operations were approximately
8,000 and 23,000 for the quarter and nine months ended September 30, 2004,
respectively, compared to approximately 7,100 and 18,600 for the quarter
and nine months ended September 30, 2003. Patient transports for CBM bases
open longer than one year (Same-Base Transports) were approximately 7,000
and 19,200 in the quarter and nine months ended September 30, 2004,
respectively, compared to approximately 7,000 and 17,700 in the quarter and
nine months ended September 30, 2003.
12
- - RECEIVABLE COLLECTIONS. The Company responds to calls for air medical
transports without pre-screening the creditworthiness of the patient. For
CBM 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. Effective
January 1, 2004, the Company instituted a price increase of approximately
5% for its CBM operations. However, net revenue after bad debt expense per
transport decreased 2.6% and 3.6% in the three and nine months ended
September 30, 2004, respectively, compared to 2003. The total provision for
expected uncollectible amounts, including contractual discounts for
Medicare/Medicaid and bad debts, increased from 42.9% of related gross
flight revenue for the nine months ended September 30, 2003, to 48.5% in
the nine months ended September 30, 2004. The Company believes the decrease
in collection rate is driven primarily by overall economic conditions.
- - 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 total fleet, are no longer in
production 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. Total maintenance expense for CBM
and HBM operations, as adjusted for the change in accounting method
described below, increased 19.1% and 22.5% in the quarter and nine months
ended September 30, 2004, respectively, compared to 2003, while total
flight volume for CBM and HBM operations increased 4.2% and 10.1%,
respectively, over the same periods. The Company continues to evaluate
opportunities to modernize its fleet in order to enhance long-term control
over maintenance costs. During 2004, the Company entered into purchase
commitments for 10 Eurocopter EC135 helicopters, with deliveries in 2004
and 2005, and 15 Bell 427 helicopters, with deliveries beginning in 2007.
Replacement models of aircraft, however, typically have higher ownership
costs than the models targeted for replacement.
- - 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 2003, the CBM division commenced
operations at two new locations which had previously been hospital-based
flight programs with either the Company or another vendor. At the
expiration of contracts in the fourth quarter of 2003 and first quarter of
2004, two of the Company's HBM customers also converted their flight
programs to the community-based model with services provided by another
operator. 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.
- - 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 a collective bargaining unit. Negotiations on a collective
bargaining agreement began in early 2004. Other employee groups may also
elect to be represented by unions in the future. Although the Company
believes that current salary and benefits arrangements are competitive with
others within the industry, the impact of a collective bargaining agreement
on the cost of operations has not yet been determined.
13
RESULTS OF OPERATIONS
The Company reported net income of $1,452,000 and $12,021,000 for the three and
nine months ended September 30, 2004, respectively, compared to net income of
$2,692,000 and $3,483,000 for the three and nine months ended September 30,
2003, respectively. Net income for the nine months ended September 30, 2004,
included the cumulative effect of a change in accounting principle of
$8,595,000, as discussed more fully below. Before the cumulative effect of the
change in accounting principle, the Company reported net income of $3,426,000
for the nine months ended September 30, 2004. An increase in flight volume for
CBM operations during the period was offset in part by increased aircraft
maintenance costs and by decreases of 2.6% and 3.6% in net reimbursement per
transport (revenue after Medicare/Medicaid discounts and bad debt expense)
during the quarter and nine months ended September 30, 2004, respectively,
compared to 2003.
CHANGE IN ACCOUNTING METHOD
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. 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).
Pro forma results, assuming the change in accounting principle had been applied
retroactively, are as follows for the quarter and nine months ended September
30, 2003 (amounts in thousands):
Three Months Ended Nine Months Ended
September 30, 2003 September 30, 2003
As Reported Pro Forma As Reported Pro Forma
-----------------------------------------------------
Aircraft operations expense $ 14,475 13,781 41,759 37,462
=====================================================
Depreciation and amortization $ 2,905 2,527 8,461 7,327
=====================================================
Net income $ 2,692 3,346 3,483 6,796
=====================================================
Basic income per share $ .28 .35 .36 .71
=====================================================
Diluted income per share $ .27 .34 .35 .68
=====================================================
FLIGHT OPERATIONS - COMMUNITY-BASED MODEL AND HOSPITAL-BASED MODEL
FLIGHT REVENUE increased $1,935,000, or 3.0%, and $28,015,000, or 16.3%, for the
three and nine months ended September 30, 2004, respectively, compared to 2003.
Flight revenue is generated by both CBM and HBM operations and is recorded net
of contractual allowances under agreements with third-party payers and
Medicare/Medicaid discounts.
- - CBM - Flight revenue increased $1,524,000, or 3.6%, to $43,489,000 for the
third quarter of 2004 and $28,047,000, or 26.6%, to $133,306,000 for the
nine months ended September 30, 2004, for the following reasons:
- Incremental revenue of $5,601,000 and $17,904,000 for the quarter and
nine months ended September 30, 2004, respectively, from the addition
of 16 new CBM bases either during or subsequent to the nine months
ended September 30, 2003.
- Purchase of certain business assets from another air medical service
provider in southeastern Arizona in May 2003, resulting in the
expansion of operations from three bases to five. Transport volume for
all bases in the region increased 22.8% in the nine months ended
September 30, 2004, compared to 2003, respectively, resulting in
incremental revenue of approximately $2,508,000.
14
- Closure of one base in the fourth quarter of 2003, one in the first
quarter of 2004, and one during the third quarter of 2004, resulting
in a decrease in revenue of approximately $897,000 and $2,532,000 for
the quarter and nine months ended September 30, 2004, respectively.
- Increase in Same Base Transports for the nine months ended September
30, 2004. Excluding the impact of the new bases and base closures
discussed above, total flight volume for all CBM operations remained
relatively unchanged during the third quarter of 2004 compared to 2003
and increased 8.4% in the nine months ended September 30, 2004,
compared to the prior year. The increase in flight volume for the nine
months is primarily attributed to improved weather conditions and an
increase in flight requests, driven in part by enhanced crew outreach
and other marketing initiatives in 2004 compared to 2003.
- Average price increase of approximately 5% for all CBM operations
effective January 1, 2004, and an average price increase of
approximately 10% effective September 1, 2004.
- Decrease caused by a change in payer mix to a higher percentage of
Medicare/Medicaid transports, resulting in higher contractual
discounts which are offset against flight revenue. The increase in
contractual discounts for the third quarter of 2004 was offset in part
by a decrease 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 $411,000, or 1.8%, to $23,469,000 for the
third quarter of 2004 and decreased $32,000 to $66,090,000 for the nine
months ended September 30, 2004, for the following reasons:
- Discontinuation of service under three contracts either prior to or
during the first quarter of 2004. In addition, during the fourth
quarter of 2003, one HBM customer converted to CBM operations. The
resulting decrease in revenue from all of these actions was
approximately $1,562,000 and $4,379,000 for the three and nine months
ended September 30, 2004, respectively.
- Revenue of approximately $396,000 and $926,000 for the quarter and
nine-month period, respectively, generated by the addition of one new
contract during the first quarter of 2004.
- Annual price increases in the majority of contracts based on changes
in the Consumer Price Index.
- Increase of 3.8% and 5.9% in flight volume for the quarter and nine
months ended September 30, 2004, respectively, for all contracts
excluding the discontinued contracts and the new contract discussed
above.
FLIGHT CENTER COSTS (consisting primarily of pilot, mechanic, and medical staff
salaries and benefits) increased $2,577,000, or 11.3%, and $9,739,000, or 15.2%,
for the quarter and nine months ended September 30, 2004, respectively, compared
to 2003. Changes by business segment are as follows:
- - CBM - Flight center costs increased $2,595,000, or 18.3% to $16,780,000 and
$9,931,000, or 25.7%, to $48,600,000 for the three and nine months ended
September 30, 2004, for the following reasons:
- Increase of approximately $2,579,000 and $8,367,000 for the quarter
and nine months ended September 30, 2004, for the addition of
personnel to staff new base locations described above.
- Decrease of approximately $492,000 and $1,172,000 for the quarter and
nine months ended September 30, 2004, due to the closure of base
locations described above.
- Increases in salaries for merit pay raises.
- Increase of approximately $162,000 and $712,000 for the quarter and
nine months ended September 30, 2004, for telecommunications costs
associated with dispatch operations.
- - HBM - Flight center costs decreased $16,000, or 0.2%, to $8,642,000 and
$192,000, or 0.8%, to $25,381,000 for the three and nine months ended
September 30, 2004, primarily due to the following:
- Decrease of approximately $582,000 and $1,767,000 for the quarter and
nine months ended September 30, 2004, due to the closure of base
locations described above.
- Increase of approximately $139,000 and $303,000 for the quarter and
nine months ended September 30, 2004, for the addition of personnel to
staff new base locations described above.
- Increases in salaries for merit pay raises.
15
AIRCRAFT OPERATING EXPENSES increased $1,606,000, or 11.1%, and $2,929,000, or
7.0%, for the three and nine months ended September 30, 2004, respectively, in
comparison to the three and nine months ended September 30, 2003. 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 15 helicopters for CBM operations and 12 for HBM operations
either during or subsequent to the first nine months of 2003. The resulting
increase in aircraft operating expenses was approximately $533,000 and
$1,703,000 for the three and nine months ended September 30, 2004.
- - Increase of approximately 21% in the number of engine events requiring
significant repair or overhaul and increase of approximately 60% in the
number of blade repairs for BK117 helicopters for the nine months ended
September 30, 2004, compared to 2003. The Company also experienced an
increase in maintenance costs for aircraft interior refurbishment, which
was required due to the age of the interiors.
- - Increase of approximately 11.4% and 17.7% for the quarter and nine months
ended September 30, 2004, respectively, in the cost of aircraft fuel per
hour flown.
- - Decrease in hull insurance rates effective July 2004.
AIRCRAFT RENTAL EXPENSE increased $660,000, or 20.3%, and $1,662,000, or 18.2%,
for the three and nine months ended September 30, 2004, respectively, in
comparison to the three and nine months ended September 30, 2003. Incremental
rental expense for 21 leased aircraft added to the Company's fleet, either
during or subsequent to the first nine months of 2003, totaled $769,000 and
$1,830,000 in the three and nine months ended September 30, 2004, respectively.
BAD DEBT EXPENSE decreased $1,232,000, or 12.1%, for the quarter ended September
30, 2004, in comparison to the prior year, but increased $12,087,000, or 54.8%,
for the nine months ended September 30, 2004. Bad debt as a percentage of
related net flight revenue was 20.0% and 25.4% for the quarter and nine months
ended September 30, 2004, respectively, compared to 24.2% and 21.0% in the
quarter and nine months ended September 30, 2003, 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, increased from 43.8% of
related gross flight revenue for the third quarter of 2003 to 49.2% for the
third quarter of 2004, and from 42.9% for the nine months ended September 30,
2003, to 48.5% for the nine months ended September 30, 2004. The Company
believes the decrease in collection rates is due to general recessionary trends
in the economy and a related increase in the number of uninsured patients and in
patients covered by Medicaid. Bad debt expense related to HBM operations and
Products Division was not significant in either 2004 or 2003.
PRODUCTS DIVISION
SALES OF MEDICAL INTERIORS AND PRODUCTS increased $271,000, or 15.9%, and
$744,000, or 16.1%, for the three and nine months ended September 30, 2004,
compared to 2003. Significant projects in 2004 included ongoing production of 13
Multi-Mission Medevac Systems for the U. S. Army's HH-60L Black Hawk helicopter,
40 litter systems for the U.S. Army's Medical Evacuation Vehicle (MEV), 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
- - $527,000 and $1,432,000 - design and manufacture of other aerospace
products
Significant projects in 2003 included the manufacture of eight modular medical
interiors for four commercial customers. In the second quarter of 2003, the
Company began the manufacture of 11 Multi-Mission Medevac Systems for the U. S.
Army's HH-60L Black Hawk helicopter. Revenue by product line for the quarter and
nine months ended September 30, 2003, respectively, was as follows:
- - $1,067,000 and $1,252,000 - design and manufacture of multi-mission
interiors
- - $534,000 and $2,957,000 - manufacture and installation of modular medical
interiors
- - $101,000 and $405,000 - design and manufacture of other aerospace products
16
COST OF MEDICAL INTERIORS AND PRODUCTS decreased $429,000, or 40.1%, and
$1,755,000, or 49.1%, for the quarter and nine months ended September 30, 2004,
respectively, compared to the prior year. The average net margin earned on
projects during 2004 was 48% compared to 22% in 2003, 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. In addition, aircraft interiors completed for commercial customers
during 2003 were for new types of aircraft in which the Company had not
previously installed its modular interior, leading to higher engineering and
documentation costs and lower profit margins. 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 decreased $176,000, or 6.1%, and $321,000,
or 3.8%, for the three and nine months ended September 30, 2004, respectively,
compared to 2003. The decrease is primarily the result of the change in the
method of accounting for major engine and airframe component overhauls and
replacements, as discussed more fully above. As part of the change in method,
the Company reversed the remaining capitalized maintenance included in fixed
assets relating to used aircraft purchases, resulting in a decrease of
approximately $378,000 and $1,134,000 in depreciation expense for the quarter
and nine months ended September 30, 2004, respectively. The decrease was offset
in part by depreciation on engine upgrades, an upgraded flight tracking system,
and computer hardware and software acquired subsequent to September 30, 2003.
GENERAL AND ADMINISTRATIVE (G&A) EXPENSES increased $1,757,000, or 32.3%, and
$4,650,000, or 29.7%, for the quarter and nine months ended September 30, 2004,
respectively, compared to 2003, reflecting the growth in the Company's
operations. G&A expenses were 10.4% and 9.9% of revenue for the three and nine
months ended September 30, 2004, respectively, compared to 8.1% and 8.9% for the
three and nine months ended September 30, 2003, respectively. G&A expenses
include accounting and finance, billing and collections, human resources,
aviation management, pilot training, and CBM program administration. During the
last half of 2003, the Company formalized the organization structure for its CBM
division along regional and program lines and added administrative personnel to
manage the daily operations of CBM bases. This increase in administrative
staffing was offset in part by a reduction in Flight Center Costs for personnel
previously assigned exclusively to a single base of operation. The Company also
increased the number of billing and collections department personnel in 2004 to
keep pace with the growth in CBM operations and to address a slowdown in
collections in early 2004. During the nine months ended September 30, 2004, the
Company also incurred costs of approximately $392,000 to prepare for the audit
of internal controls required by Section 404 of the Sarbanes-Oxley Act of 2002.
These increases were offset in part by a decrease in aviation management costs
resulting from the consolidation of FAA Part 135 operating certificates from 4
certificates at the beginning of 2003 to 2 certificates by the beginning of
2004.
INTEREST EXPENSE decreased $402,000, or 18.1%, and $216,000, or 3.5%, in the
quarter and nine months ended September 30, 2004, respectively, compared to
2003, as a result of changes in the average balance outstanding against the
Company's line of credit, decreases in principal balances as a result of
regularly scheduled payments, and the refinancing of $17.5 million of debt at
lower interest rates during the fourth quarter of 2003 and the first quarter of
2004. The average balance outstanding against the line of credit was
approximately $16.5 million and $18.5 million during the three and nine months
ended September 30, 2004, respectively, compared to $17.3 million and $16.2
million during the three and nine months ended September 30, 2003, respectively.
The Company recorded INCOME TAX EXPENSE of $2,220,000 in 2004 and $2,227,000 in
2003, both at an effective rate of approximately 39%.
17
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $50,504,000 as of September 30, 2004,
compared to $43,682,000 at December 31, 2003. The change in working capital
position is primarily attributable to the following:
- - Increase of $3,096,000 in net receivables consistent with the increased
revenue for the CBM division resulting from new base expansions and
increases in flight volume.
- - Decrease of $7,702,000 in short-term accrued overhaul and parts replacement
costs liabilities, due to the change in the method of accounting for major
engine and airframe component overhaul costs from the accrual method of
accounting to the direct expense method. Effective January 1, 2004, the
Company reversed its major overhaul accrual for all owned and leased
aircraft.
- - Increase of $2,850,000 in deferred income tax liabilities, primarily due to
the change in the method of accounting for major engine and airframe
component overhaul costs from the accrual method of accounting to the
direct expense method. Previously, the accrual method of accounting for
engine and airframe component overhaul costs resulted in a deferred tax
asset, which had both a current and a long-term component.
SOURCES AND USES OF CASH
The Company had cash and cash equivalents of $7,461,000 as of September 30,
2004, compared to $5,574,000 at December 31, 2003. Cash generated by operations
in the nine months ended September 30, 2004, totaled $13,177,000 compared to
$211,000 in 2003. Receivable balances, net of bad debt expense, increased
$3,096,000 in 2004 compared to $14,704,000 in 2003 despite the continued growth
in operations. The smaller increase reflects the decline in the overall
collection rate for receivables in 2004 compared to 2003 and the results of the
Company's efforts to improve the pace of collections. Total cash collected
against CBM receivable balances was $98.2 million in the nine months ended
September 30, 2004, compared to $69.0 million in the nine months ended September
30, 2003.
Cash used by investing activities totaled $7,149,000 in 2004 compared to
$2,254,000 in 2003. Equipment acquisitions in 2004 consisted primarily of
medical interior and avionics installations, information systems hardware and
software, and rotable equipment. Capital lease financing for the information
systems acquisitions is expected to be finalized during the fourth quarter of
2004. In 2004 the Company received $1.2 million for the sale of one of its
aircraft which will be 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. Equipment acquisitions
in 2003 consisted primarily of medical interior and avionics installations,
upgrades for existing equipment, or rotable equipment. In 2003, the Company
received $116,000 in full payment of a note receivable.
Financing activities used $4,141,000 in 2004 compared to generating $3,815,000
in 2003. 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 primary
use of cash in both 2004 and 2003 was regularly scheduled payments of long-term
debt and capital lease obligations. These payments were offset in 2003 by draws
against the Company's line of credit and proceeds from new note agreements.
In January 2004 the Company originated a note payable of $1,039,000 with
interest at 5.08% to refinance existing debt with a higher interest rate and to
fund the acquisition of computer equipment and other capital expenditures; the
note is payable through January 2010. In March 2004 the Company originated a
note payable of $7,492,000 with interest at 5.60% to refinance existing debt
with a higher interest rate; the note is payable through April 2010.
In March 2004, the Company entered into a commitment agreement to purchase 10
Eurocopter EC135 helicopters for approximately $34.3 million, with deliveries
scheduled through the first quarter of 2005. As of September 30, 2004, the
Company had taken delivery of 5 helicopters under the agreement.
In July 2004, the Company entered into a commitment agreement to purchase 15
Bell 427 helicopters for approximately $55.5 million, beginning in 2007, with a
minimum of three deliveries per year. The agreement provides for special
incentives, including a trade-in option for up to 15 Bell 222 helicopters, with
minimum guaranteed trade-in values. The Company intends to place the new EC135's
and Bell 427's primarily into existing bases and to either sell the aircraft
which are replaced or redeploy them into the backup fleet.
18
OUTLOOK FOR 2004
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
The Company opened CBM operations at six new locations since the beginning of
2004, including one in Pennsylvania during the third quarter, and expects to
open a new location in Kentucky in the fourth quarter. CBM flight volume at all
other locations is expected to be consistent during 2004 with historical levels,
subject to seasonal, weather-related fluctuations. The Company continues to
evaluate opportunities to expand the CBM model in other communities.
Hospital-Based Model
In March 2004, the Company began operations under a five-year contract with a
new customer in Florida. The Company has renewed all four contracts which were
due for renewal in 2004, including the following in the third quarter: one in
Virginia for a three-year term; one in Nebraska for a one-year term; and one in
Nebraska for a five-year term. The Company expects to expand two existing
contracts in Colorado and North Carolina to additional satellite bases in the
fourth quarter of 2004. The Company expects 2004 flight activity for continuing
hospital contracts to remain consistent with historical levels.
Products Division
As of September 30, 2004, the Company was continuing the production of 13 HH-60L
units and 19 MEV units for the U.S. Army and the production of a multi-mission
interior in a Sikorsky FIREHAWK helicopter for the Los Angeles County Fire
Department. Work on these three contracts is expected to continue throughout the
remainder of 2004 and into the second quarter of 2005. In the fourth quarter of
2004 the Company also received a contract for the production of two modular
medical interiors for a commercial customer, with delivery scheduled in the
first and second quarters of 2005. Remaining revenue for all contracts as of
September 30, 2004, 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 15 HH-60L units under the program, in addition
to the 13 currently under contract. The U.S. Army has also forecasted a
requirement for a total of 118 MEV units over 4 years; the Company has
previously delivered 63 units, in addition to the 19 units currently under
contract. There is no assurance that orders for additional units will be
received in future periods.
All Segments
In the fourth quarter of 2004 the Company implemented new finance and accounting
software and expects to implement new software for several other major
information technology systems in 2005. The majority of the cost of new systems
is expected to be financed through capital and operating lease agreements.
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 2004. The Company also had approximately $20,855,000
in borrowing capacity available under its revolving credit facility as of
September 30, 2004.
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 2004" and
those described below.
19
- - Highly leveraged balance sheet - The Company is obligated under debt
facilities providing for up to approximately $105.9 million of
indebtedness, of which approximately $86.0 million was outstanding at
September 30, 2004. 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 subordinated notes and senior credit
facility, into which the Company entered to finance the acquisition of RMH,
both contain 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 will 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 agreements or to
maintain the required financial ratios could result in an event of default
and accelerate payment of the principal balances due under the subordinated
notes and the senior 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 the Company will be able
to obtain such waivers without payment of significant cash or equity
compensation to the lenders.
- - Flight volume - All CBM revenue and approximately 35% of HBM revenue is
dependent upon flight volume. Approximately 30% 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.
- - Employee unionization - In September 2003, the Company's pilots voted to be
represented by a collective bargaining unit, the Office and Professional
Employees International Union. Negotiations on a collective bargaining
agreement began in early 2004. Other employee groups may also elect to be
represented by unions in the future. Although the Company believes that
current salary and benefits arrangements are competitive with others within
the industry, the impact of a collective bargaining agreement on the cost
of operations has not yet been determined.
- - 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 hospital customers. Changes in laws or regulations or reimbursement
rates could have a material adverse impact on the Company's cost of
operations or revenue from flight operations.
- - 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.
20
- - 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 37% 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
relationship with such hospitals and operating results.
- - 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 July 20, 2004, the Company
was aware of one foreign person who, according to recent public securities
filings, is believed to hold approximately 10.1% 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.
- - Acquisitions and integration - The Company has grown significantly through
acquisitions in the past and will continue to pursue acquisitions in the
future. With any large acquisition, a significant effort is required to
assimilate the operations, financial and accounting practices, and MIS
systems, and to integrate key personnel from the acquired business.
Acquisitions may cause disruptions in Company operations and divert
management's attention from day-to-day operations. The Company may not
realize the anticipated benefits of past or future acquisitions,
profitability may suffer due to acquisition-related costs or unanticipated
liabilities, and the Company's stock price may decrease if the financial
markets consider the acquisitions to be inappropriately priced.
- - 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.
- - 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 Eurocopter 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 are generally 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.
21
- - 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 for the year ending December
31, 2004. The Company continues to devote substantial time and resources to
the documentation and testing of internal controls. There is no indication
that management will be unable to favorably report on internal controls nor
that the Company's independent auditors will be unable to attest to
management's findings. Both management and the auditors, however, must
complete their processes, which have never been undertaken before. As a
result, the Company cannot offer assurance that the work necessary to fully
comply with the requirements of Section 404 will be completed timely or
that management or the auditors will conclude that internal controls are
effective. 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, but it may 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. 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
medical capability of the aircraft offered. The Company's competition in
the aircraft interior design and manufacturing industry comes primarily
from two companies based in the United States and one in Europe.
Competition is based mainly on product features, performance, price, 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.
- - 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.
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, aircraft overhaul costs, 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 CBM flight
revenue for the nine months ended September 30, 2004, a change of 1% in the
percentage of estimated contractual discounts would have resulted in a change of
approximately $1,929,000 in flight revenue.
22
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 creditworthiness 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 CBM net flight revenue for the nine months ended September 30,
2004, a change of 1% in the percentage of estimated uncollectible accounts would
have resulted in a change of approximately $1,333,000 in bad debt expense.
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 maintenance 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.
Aircraft Overhaul Costs
The Company operates under an FAA-approved continuous inspection and maintenance
program. The Company accounts for maintenance activities on the direct expense
method. Under this method, commencing January 1, 2004, all maintenance costs are
recognized as expense as costs are incurred. Prior to January 1, 2004, the
Company accrued for major engine and airframe component overhaul costs based on
usage of the aircraft component over the period between overhauls or
replacements in advance of performing the maintenance services.
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.
23
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 $15,114,000
outstanding against the line of credit and $2,176,000 in notes payable. Based on
the amounts outstanding at September 30, 2004, the annual impact of a 1% change
in interest rates would be approximately $173,000. Interest rates on these
instruments approximate current market rates as of September 30, 2004.
Periodically the Company enters into interest rate risk hedges to minimize
exposure to the effect of an increase in interest rates.
ITEM 4. 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 evaluated, with the participation of the
Certifying Officers, the effectiveness of disclosure controls and procedures as
of September 30, 2004, pursuant to Rule 13a-15(b) under the Exchange Act. Based
on that evaluation, the Certifying Officers have concluded that, as of September
30, 2004, the Company's disclosure controls and procedures were effective.
There were no significant changes in the Company's internal controls 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 fourth
quarter of 2004, the Company upgraded its hardware and software systems relating
to finance and accounting and expects to upgrade the systems relating to
inventory, purchasing, and dispatch and communications in 2005.
24
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
None.
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
------ -----------------------
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
(b) Reports on Form 8-K
None
25
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 15, 2004 By \s\ Aaron D. Todd
-------------------------------------------
Aaron D. Todd
Chief Executive Officer
(Principal Executive Officer)
Date: November 15, 2004 By \s\ Trent J. Carman
-------------------------------------------
Trent J. Carman
Chief Financial Officer
(Principal Financial Officer)
Date: November 15, 2004 By \s\ Sharon J. Keck
-------------------------------------------
Sharon J. Keck
Chief Accounting Officer
(Principal Accounting Officer)
26