UNITED STATES 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 March 31, 2005
---------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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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 (I.R.S. Employer Identification Number)
Incorporation or Organization)
7301 South Peoria, Englewood, Colorado 80112
- -------------------------------------- -----
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (303) 792-7400
--------------
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
--- ---
The number of shares of Common Stock, par value $.06, outstanding as of April
29, 2005, was 11,030,388.
TABLE OF CONTENTS
Form 10-Q
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets - March 31, 2005 and December 31, 2004 1
Consolidated Statements of Operations for the three months
ended March 31, 2005 and 2004 3
Consolidated Statements of Cash Flows for the three months ended
March 31, 2005 and 2004 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 23
Item 4. Controls and Procedures 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Changes in Securities 24
Item 3. Defaults upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits 24
SIGNATURES 25
PART I: FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share amounts)
(unaudited)
MARCH 31, DECEMBER 31,
2005 2004
--------------------------
Assets
- ------
Current assets:
Cash and cash equivalents $ 2,761 2,603
Current installments of notes receivable 62 61
Receivables:
Trade 90,268 89,218
Less allowance for doubtful accounts (26,188) (26,040)
--------------------------
64,080 63,178
Other 3,318 4,520
--------------------------
67,398 67,698
--------------------------
Inventories 8,954 8,667
Work-in-process on medical interiors and products contracts 367 645
Assets held for sale 582 5,705
Costs and estimated earnings in excess of billings on
uncompleted contracts 2,156 2,938
Prepaid expenses and other 2,561 2,686
--------------------------
Total current assets 84,841 91,003
--------------------------
Property and equipment:
Land 190 190
Flight and ground support equipment 139,777 137,742
Buildings and office equipment 11,783 11,805
--------------------------
151,750 149,737
Less accumulated depreciation and amortization (55,491) (52,985)
--------------------------
Net property and equipment 96,259 96,752
--------------------------
Goodwill 6,485 6,485
Notes and other receivables, less current installments 331 572
Other assets, net of accumulated amortization of $2,148 and $2,108
at March 31, 2005 and December 31, 2004, respectively 9,601 9,911
--------------------------
Total assets $ 197,517 204,723
==========================
(Continued)
1
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS, CONTINUED
(Amounts in thousands, except share and per share amounts)
(unaudited)
MARCH 31, DECEMBER 31,
2005 2004
------------------------
Liabilities and Stockholders' Equity
- ------------------------------------
Current liabilities:
Notes payable $ -- 5,105
Current installments of long-term debt 7,846 6,041
Current installments of obligations under capital leases 321 410
Accounts payable 6,578 7,193
Deferred revenue 4,061 3,883
Billings in excess of costs and estimated earnings on
uncompleted contracts 190 309
Accrued wages and compensated absences 5,831 3,668
Deferred income taxes 3,913 4,387
Due to third party payers 1,789 2,867
Other accrued liabilities 6,160 8,291
------------------------
Total current liabilities 36,689 42,154
Long-term debt, less current installments (note 3) 70,961 72,693
Obligations under capital leases, less current installments 198 249
Deferred income taxes 8,481 8,284
Other liabilities 8,460 8,264
------------------------
Total liabilities 124,789 131,644
------------------------
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 11,019,761 and 10,997,380 shares at
March 31, 2005 and December 31, 2004, respectively 661 660
Additional paid-in capital 65,071 64,955
Retained earnings 6,996 7,464
Treasury stock at par, 4,040 common shares at March
31, 2005 and December 31, 2004 -- --
------------------------
Total stockholders' equity 72,728 73,079
------------------------
Total liabilities and stockholders' equity $ 197,517 204,723
========================
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 MARCH 31,
---------------------------------
2005 2004
---------------------------------
Revenue:
Flight revenue $ 66,958 59,577
Sales of medical interiors and products 1,524 2,025
Parts and maintenance sales and services 26 32
---------------------------------
68,508 61,634
---------------------------------
Operating expenses:
Flight centers 25,746 23,046
Aircraft operations 14,929 13,721
Aircraft rental 4,280 3,330
Cost of medical interiors and products sold 843 638
Cost of parts and maintenance sales and services 47 47
Depreciation and amortization 2,897 2,677
Bad debt expense 10,111 9,740
Loss on disposition of assets, net 107 4
General and administrative 8,763 7,522
---------------------------------
67,723 60,725
---------------------------------
Operating income 785 909
Other income (expense):
Interest expense (1,893) (2,087)
Other, net 373 286
---------------------------------
Loss before income tax benefit and cumulative effect of change in
accounting principle (735) (892)
Income tax benefit 267 348
---------------------------------
Loss before cumulative effect of change in accounting principle (468) (544)
Cumulative effect of change in method of accounting for maintenance
costs, net of income taxes (note 2) -- 8,595
---------------------------------
Net income (loss) $ (468) 8,051
=================================
(Continued)
3
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except share and per share amounts)
(unaudited)
THREE MONTHS ENDED MARCH 31,
---------------------------------
2005 2004
---------------------------------
Income (loss) per common share - basic and diluted (note 4):
Loss before cumulative effect of change in accounting principle $ (.04) (.05)
Cumulative effect of change in method of accounting for
maintenance costs, net of income taxes -- .79
---------------------------------
Net income (loss) $ (.04) .74
=================================
Weighted average number of common shares outstanding - basic 10,998,232 10,832,455
=================================
Weighted average number of common shares outstanding - diluted 10,998,232 10,832,455
=================================
See accompanying notes to consolidated financial statements.
4
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(unaudited)
THREE MONTHS ENDED MARCH 31,
---------------------------------
2005 2004
---------------------------------
Cash flows from operating activities:
Net income (loss) $ (468) 8,051
Adjustments to reconcile net income (loss) to net cash provided (used) by
operating activities:
Depreciation and amortization expense 2,897 2,677
Bad debt expense 10,111 9,740
Deferred income tax benefit (277) (339)
Loss on retirement and sale of equipment, net 107 4
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 539 (692)
Increase in receivables (9,811) (17,632)
Decrease (increase) in inventories (287) 14
Decrease in work-in-process on medical interiors and costs in excess of
billings 1,060 177
Decrease in accounts payable, other accrued liabilities, and other liabilities (1,465) (2,017)
Increase in deferred revenue and billings in excess of costs 59 2,028
---------------------------------
Net cash provided (used) by operating activities 2,465 (6,584)
---------------------------------
Cash flows from investing activities:
Acquisition of equipment and leasehold improvements (2,761) (4,433)
Proceeds from disposition and sale of equipment 463 9
Decrease in notes receivable and other assets, net 252 67
---------------------------------
Net cash used by investing activities (2,046) (4,357)
---------------------------------
(Continued)
5
AIR METHODS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
(Amounts in thousands)
(unaudited)
THREE MONTHS ENDED MARCH 31,
2005 2004
---------------------------------
Cash flows from financing activities:
Net borrowings under line of credit $ 1,836 8,169
Proceeds from long-term debt -- 8,531
Payments of long-term debt (2,074) (9,678)
Payments of capital lease obligations (140) (165)
Payments for purchases of common stock -- (416)
Proceeds from issuance of common stock, net 117 462
---------------------------------
Net cash provided (used) by financing activities (261) 6,903
---------------------------------
Increase (decrease) in cash and cash equivalents 158 (4,038)
Cash and cash equivalents at beginning of period 2,603 5,574
---------------------------------
Cash and cash equivalents at end of period $ 2,761 1,536
=================================
Non-cash investing and financing activities:
In the quarter ended March 31, 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 $85 by applying a purchase deposit against it and entered into
a note payable of $396 to finance insurance policies.
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).
See accompanying notes to consolidated financial statements.
6
AIR METHODS CORPORATION AND SUBSIDIARIES
NOTES TO 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
NOTES TO 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
provides 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 approximately $1.8 million in debt origination costs
and note discount related to the subordinated debt and paid a prepayment
penalty of approximately $1.4 million to the holders of the subordinated
debt. For the first quarter of 2005, the effective interest rate on the
subordinated debt, including amortization of debt origination costs and
note discount, was 16.2%. At March 31, 2005, the Company was not in
compliance with covenants which require a minimum fixed charge ratio (as
defined in the agreements) under both its subordinated debt agreement and
senior revolving credit facility. The debt is not classified as current in
the consolidated financial statements as a result of the covenant
violations because of the refinancing described above.
(4) INCOME (LOSS) PER SHARE
--------------------------
Basic earnings per share is computed by dividing net income (loss) by
the weighted average number of common shares outstanding during the period.
Diluted earnings per share is computed by dividing net income by all
outstanding and dilutive potential common shares during the period.
The reconciliation of basic to diluted weighted average common shares
outstanding is as follows for the quarters ended March 31:
2005 2004
---------- ----------
Weighted average number of common shares outstanding - basic 10,998,232 10,832,455
Dilutive effect of:
Common stock options -- --
Common stock warrants -- --
----------------------
Weighted average number of common shares outstanding - diluted 10,998,232 10,832,455
======================
Common stock options totaling 1,012,500 and 1,137,856 and common stock
warrants totaling 574,716 and 599,716 were not included in the diluted
shares outstanding for the quarters ended March 31, 2005 and 2004,
respectively, because their effect would have been anti-dilutive.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(5) STOCKHOLDERS' EQUITY
---------------------
Changes in stockholders' equity for the three months ended March 31,
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 22,381 117
Net loss -- (468)
----------------------------
Balances at March 31, 2005 11,015,721 $72,728
============================
(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
Statement 123, the Company's net income and income per share would have
been reduced to the pro forma amounts indicated below for the quarters
ended March 31 (amounts in thousands, except per share amounts):
2005 2004
------ ------
Net loss before cumulative effect of change in
accounting principle:
As reported $(468) (544)
Pro forma (544) (616)
Net income (loss):
As reported $(468) 8,051
Pro forma (544) 7,979
Basic and diluted loss per share before cumulative
effect of change in accounting principle:
As reported $(.04) (.05)
Pro forma (.05) (.06)
Basic and diluted net income (loss) per share:
As reported $(.04) .74
Pro forma (.05) .74
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 the first quarter of 2004: dividend
yield of 0%; expected volatility of 30%; risk-free interest rates of 3.3%;
and expected life of 4 years. The weighted average fair value of options
granted during the quarter ended March 31, 2004, was $2.81. No options were
granted during the first quarter of 2005.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(6) STOCK-BASED COMPENSATION, CONTINUED
-----------------------------------
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 has not yet determined which transition method it will apply nor
the impact of adopting Statement 123R on its financial position or results
of operations.
(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.
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(7) BUSINESS SEGMENT INFORMATION, CONTINUED
---------------------------------------
Products Corporate Intersegment
FOR QUARTER ENDED MARCH 31: CBM HBM Division Activities Eliminations Consolidated
- -------------------------------------------------------------------------------------------------------------------
2005
External revenue $44,618 22,366 1,524 -- -- 68,508
Intersegment revenue -- -- 2,787 -- (2,787) --
---------------------------------------------------------------------
Total revenue 44,618 22,366 4,311 -- (2,787) 68,508
---------------------------------------------------------------------
Operating expenses 31,835 19,564 3,321 2,312 (2,317) 54,715
Depreciation & amortization 1,397 1,348 91 61 -- 2,897
Bad debt expense 10,108 3 -- -- -- 10,111
Interest expense 976 892 -- 25 -- 1,893
Other income, net (226) (147) -- (373)
Income tax benefit -- -- -- (267) -- (267)
---------------------------------------------------------------------
Segment net income (loss) $ 528 559 899 (1,984) (470) (468)
=====================================================================
Total assets $66,995 N/A N/A 132,686 (2,164) 197,517
=====================================================================
2004
External revenue $39,044 20,565 2,025 -- -- 61,634
Intersegment revenue -- -- 2,166 -- (2,166) --
---------------------------------------------------------------------
Total revenue 39,044 20,565 4,191 -- (2,166) 61,634
---------------------------------------------------------------------
Operating expenses 27,402 18,206 2,483 1,984 (1,767) 48,308
Depreciation & amortization 1,330 1,257 42 48 -- 2,677
Bad debt expense 9,740 -- -- -- -- 9,740
Interest expense 1,029 967 -- 91 -- 2,087
Other income, net (229) -- -- (57) -- (286)
Income tax benefit -- -- -- (348) -- (348)
---------------------------------------------------------------------
Segment net income (loss) before cumulative
effect of change in accounting principle (228) 135 1,666 (1,718) (399) (544)
Cumulative effect of change in accounting
principle, net -- -- -- 8,595 -- 8,595
---------------------------------------------------------------------
Segment net income (loss) $ (228) 135 1,666 6,877 (399) 8,051
=====================================================================
Total assets $56,027 N/A N/A 146,799 (2,164) 200,662
=====================================================================
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; 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 first quarter of 2005 the CBM Division generated 65% of
the Company's total revenue, increasing from 63% in the first quarter of
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 65% of total contract
revenue) and hourly flight fees (approximately 35% of total contract
revenue) billed to hospital customers. In the first quarter of 2005 the HBM
Division generated 33% of the Company's total revenue, decreasing from 34%
in 2004.
- - Products Division - designs, manufactures, and installs aircraft medical
interiors and other aerospace and medical transport products for
domestic and international customers. In the first quarter of 2005 the
Products Division generated 2% of the Company's total revenue, decreasing
from 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 35% of HBM revenue. By contrast,
approximately 66% 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
6,700 for the first quarter of 2005 compared to approximately 7,000 for the
first quarter of 2004. Patient transports for CBM bases open longer than
one year (Same-Base Transports) were approximately 6,200 in the first
quarter of 2005 compared to approximately 6,800 in the first three months
of 2004. During the first quarter of 2005, the Company's CBM operations had
approximately 500, or 31%, more cancellations as a result of unfavorable
weather conditions than during 2004 for bases which had been in operation
for longer than one year.
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. 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
22.2% in the first quarter of 2005 compared to the first quarter of 2004.
The total allowance for expected uncollectible amounts, including
contractual discounts for Medicare/Medicaid and bad debts, decreased from
49.6% of related gross flight revenue for the quarter ended March 31, 2004,
to 45.1% in the first quarter of 2005. In 2004 the Company increased
staffing in the billing and collections department, segmented billing by
region, and hired a national billing director. 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. Days' sales outstanding, measured by
comparing net revenue for the previous 12-month period to outstanding net
accounts receivable, decreased from 148 days at March 31, 2004, to 105 days
at March 31, 2005.
- - 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 helicopters within the Company's
fleet, representing 27% of the total rotor wing 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 increased 10.3% in the first quarter of 2005 compared to
2004, while total flight volume for CBM and HBM operations increased 1.9%
over the same period. The Company continues to evaluate opportunities to
modernize its fleet in order to enhance long-term control over maintenance
costs. Replacement models of aircraft, however, typically have higher
ownership costs than the models targeted for replacement. In 2004 the
Company entered into two long-term purchase commitments for a total of 25
aircraft, designed to replace the discontinued models and other older
aircraft over the next five to seven years. As of March 31, 2005, the
Company had taken delivery of ten aircraft under these commitments.
- - 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. 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 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.
13
- - EMPLOYEE RELATIONS. In September 2003, the Company's pilots voted to be
represented by a collective bargaining unit. Negotiations on a
collective bargaining agreement have continued since early 2004, and a
mediator was appointed in the fourth quarter of 2004 to assist with
resolving differences between the parties. 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.
RESULTS OF OPERATIONS
The Company reported a net loss of $468,000 for the three months ended March 31,
2005, compared to net income of $8,051,000 for the three months ended March 31,
2004. Net income for the first quarter of 2004 included the cumulative effect of
a change in accounting principle of $8,595,000, as discussed more fully in Note
2 to the consolidated financial statements included in Item 1 of this report.
Before the cumulative effect of the change in accounting principle, the Company
reported a net loss of $544,000 for the first quarter of 2004. A decrease of
9.3% in Same-Base Transports for CBM bases was offset during the first quarter
of 2005 by an increase of 22.2% in net reimbursement (revenue after
Medicare/Medicaid discounts and bad debt expense) for CBM operations. In
addition, the average net margin earned on medical interior sales declined from
49% in the first quarter of 2004 to 29% in the first quarter of 2005. The three
months ended March 31, 2005, also included an increase in expense of $593,000
for the self-insured portion of workers compensation premiums as a result of two
fatal accidents experienced in the first quarter.
FLIGHT OPERATIONS - COMMUNITY-BASED MODEL AND HOSPITAL-BASED MODEL
FLIGHT REVENUE increased $7,381,000, or 12.4%, from $59,577,000 to $66,958,000
for the three months ended March 31, 2005, compared to 2004. 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 $5,587,000, or 14.3%, to $44,599,000 in the
three months ended March 31, 2005, compared to 2004, for the following
reasons:
- Revenue of $3,584,000 from the addition of nine new CBM bases either
during or subsequent to the first quarter of 2004.
- Closure of one base in the first quarter of 2004 and one during the
third quarter of 2004, resulting in a decrease in revenue of
approximately $565,000.
- Average price increases of approximately 10% for all CBM operations
effective September 2004 and approximately 7% effective March 1,
2005.
- Decrease in Same-Base Transports. Excluding the impact of the new
bases and base closures discussed above, total flight volume for
all CBM operations decreased 9.3% in the first quarter of 2005
compared to the prior year. The decrease in flight volume is primarily
attributed to adverse weather conditions. Cancellations due to
unfavorable weather conditions were approximately 30.6% higher in the
first quarter of 2005 compared to 2004.
- - HBM - Flight revenue increased $1,794,000, or 8.7%, to $22,359,000 for the
quarter ended March 31, 2005, for the following reasons:
- Revenue of $1,451,000 from the addition of two new bases and the
expansion of three contracts either during or subsequent to the
first quarter of 2004.
- Discontinuation of service under one contract during the first quarter
of 2004, resulting in a decrease in revenue of approximately
$88,000.
- Annual price increases in the majority of contracts based on changes
in the Consumer Price Index and in hull insurance rates.
- Decrease of 4.9% in flight volume for all contracts excluding the new
contracts, contract expansions, and discontinued contract
discussed above.
14
FLIGHT CENTER COSTS (consisting primarily of pilot, mechanic, and medical staff
salaries and benefits) increased $2,700,000, or 11.7%, to $25,746,000 for the
quarter ended March 31, 2005, compared to 2004. Flight center costs in the first
quarter of 2005 included an increase of $505,000 in workers compensation expense
as a result of two fatal accidents experienced during the quarter. Other changes
by business segment are as follows:
- - CBM - Flight center costs increased $2,128,000, or 14.6%, to $16,715,000
for the following reasons:
- Approximately $1,812,000 for the addition of personnel to staff new
base locations described above.
- Decrease of approximately $335,000 due to the closure of base
locations described above.
- - HBM - Flight center costs increased $574,000, or 6.8%, to $9,032,000
primarily due to the following:
- Approximately $616,000 for the addition of personnel to staff new base
locations described above.
- Decrease of approximately $35,000 due to the closure of base locations
described above.
AIRCRAFT OPERATING EXPENSES increased $1,208,000, or 8.8%, for the quarter ended
March 31, 2005, in comparison to the quarter ended March 31, 2004. Aircraft
operating expenses consist primarily of fuel, insurance, and maintenance costs
and generally are a function of the size of the fleet, type of aircraft flown,
and number of hours flown. The increase in costs is due to the following:
- - Addition of 13 helicopters for CBM operations and 7 helicopters for HBM
operations after March 31, 2004, resulting in an increase of
approximately $991,000.
- - Increase of approximately 9.5% in the cost of aircraft fuel per hour flown.
- - Decrease in hull insurance rates effective July 2004.
AIRCRAFT RENTAL EXPENSE increased $950,000, or 28.5%, for the first quarter of
2005 compared to the first quarter of 2004. Rental expense for 11 leased
aircraft added to the Company's fleet since March 31, 2004, totaled $801,000 in
the three months ended March 31, 2005.
BAD DEBT EXPENSE increased $371,000, or 3.8%, for the quarter ended March 31,
2005, compared to 2004, due primarily to the increase in related flight revenue.
Bad debt expense as a percentage of related net flight revenue decreased from
25.0% in the first quarter of 2004 to 22.5% in the first quarter of 2005. Flight
revenue is recorded net of Medicare/Medicaid discounts. The total allowance for
expected uncollectible amounts, including contractual discounts and bad debts,
decreased from 49.6% of related gross flight revenue for the quarter ended March
31, 2004, to 45.1% in the first quarter of 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. In addition, transports covered by private
insurance, which tends to reimburse at a higher rate than other types of payers,
accounted for 39% of total transports in the first quarter of 2005, compared to
32% in the first quarter of 2004. Reimbursement rates are typically higher for
transports covered by private insurance than for those covered by
Medicare/Medicaid. Bad debt expense related to HBM operations and Products
Division was not significant in either 2005 or 2004.
MEDICAL INTERIORS AND PRODUCTS
SALES OF MEDICAL INTERIORS AND PRODUCTS decreased $501,000, or 24.7%, from
$2,025,000 for the three months ended March 31, 2004, to $1,524,000 for the
first quarter of 2005. Significant projects in the first quarter of 2005
included continued production of 13 Multi-Mission Medevac Systems for the U. S.
Army's HH-60L Black Hawk helicopter, 19 litter systems for the U.S. Army's
Medical Evacuation Vehicle (MEV), 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. Production of the 19 MEV units and
11 of the HH-60L units was completed during the first quarter. Revenue by
product line was as follows:
- - $404,000 - manufacture and installation of modular medical interiors
- - $786,000 - manufacture of multi-mission interiors
- - $334,000 - design and manufacture of other aerospace and medical transport
products
15
Significant projects in the first quarter of 2004 included ongoing production of
11 HH-60L units and 21 MEV units. Revenue by product line was as follows:
- - $209,000 - manufacture and installation of modular medical interiors
- - $1,191,000 - manufacture of multi-mission interiors
- - $625,000 - design and manufacture of other aerospace and medical transport
products
COST OF MEDICAL INTERIORS AND PRODUCTS increased $205,000, or 32.1%, for the
three months ended March 31, 2005, as compared to the previous year. The average
net margin earned on projects during the first quarter of 2005 was 29% compared
to 49% in 2004, primarily due to the change in product mix. The margins earned
on multi-mission interiors are 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.
GENERAL EXPENSES
DEPRECIATION AND AMORTIZATION EXPENSE increased $220,000, or 8.2% for the three
months ended March 31, 2005, compared to 2004, primarily as a result of upgrades
to aircraft, engines, and avionics systems and to the purchase of rotable
equipment.
GENERAL AND ADMINISTRATIVE (G&A) EXPENSES increased $1,241,000, or 16.5%, for
the quarter ended March 31, 2005, compared to the quarter ended March 31, 2004,
reflecting 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 12.8% of revenue for 2005, compared to 12.2%
for 2004. During the first quarter of 2005, the Company also incurred
approximately $298,000 in audit fees and outside consultant costs related to the
audit of internal controls required by Section 404 of the Sarbanes-Oxley Act of
2002 for the year ended December 31, 2004. The Company also increased the number
of billing and collections department personnel by 33% during the first quarter
of 2004 to address slowdowns in collections and incurred three months of costs
at the higher staffing level in 2005, compared to a partial quarter in 2004.
INTEREST EXPENSE decreased $194,000, or 9.3%, in the first quarter of 2005,
compared to the first quarter of 2004, primarily 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 of
credit was $17.0 million in the first quarter of 2005 compared to $19.6 million
in the first quarter of 2004.
DEFERRED INCOME TAX BENEFIT was $277,000 and $339,000 in the first quarter of
2005 and 2004, respectively, both at an effective rate of approximately 39%. In
the first quarter of 2005, the Company also recognized $10,000 of current income
tax expense for estimated state income taxes.
LIQUIDITY AND CAPITAL RESOURCES
The Company's working capital position as of March 31, 2005, was $48,152,000,
relatively unchanged from $48,849,000 at December 31, 2004.
The Company had cash and cash equivalents of $2,761,000 as of March 31, 2005,
compared to $2,603,000 at December 31, 2004. Company operations generated
$2,465,000 in cash in the first quarter of 2005 compared to using $6,584,000 in
2004. Receivable balances, net of bad debt expense, decreased $300,000 in the
first quarter of 2005 compared to increasing $7,892,000 in the first quarter of
2004, reflecting a slower rate of growth in 2005 and the results of the
Company's efforts to improve the pace of collections. Days' sales outstanding
for CBM operations, measured by comparing net revenue for the previous 6-month
period to outstanding net accounts receivable, decreased from 148 days at March
31, 2004, to 105 days at March 31, 2005.
16
Cash used by investing activities totaled $2,046,000 in 2005 compared to
$4,357,000 in 2004. Equipment acquisitions in the first quarter of 2005
consisted primarily of rotable equipment and upgrades to aircraft, engines, and
avionics systems. In the first quarter of 2005, the Company received $463,000 in
insurance proceeds for an aircraft destroyed in an accident. Equipment
acquisitions in the first quarter of 2004 consisted primarily of medical
interior and avionics installations, information systems hardware and software,
and rotable equipment.
Financing activities used $261,000 in 2005 compared to generating $6,903,000 in
2004. The primary use of cash in both 2005 and 2004 was regularly scheduled
payments of long-term debt and capital lease obligations. In 2004 these payments
were offset by proceeds from new note agreements, which were used primarily to
refinance existing debt with higher interest rates, and by higher draws against
the Company's line of credit.
On May 9, 2005, the Company amended and restated its senior revolving credit
facility and repaid its subordinated debt facility. The amendment provides 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 approximately $1.8 million in debt origination costs and note discount
related to the subordinated debt and paid a prepayment penalty of approximately
$1.4 million to the holders of the subordinated debt. For the first quarter of
2005, the effective interest rate on the subordinated debt, including
amortization of debt origination costs and note discount, was 16.2%. At March
31, 2005, the Company was not in compliance with covenants which require a
minimum fixed charge ratio (as defined in the agreements) under both its
subordinated debt agreement and senior revolving credit facility. The debt is
not classified as current in the consolidated financial statements as a result
of the covenant violations because of the refinancing described above.
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. CBM flight volume at
all other locations during 2005 is expected to be consistent 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 April 2005, the Company expanded three existing contracts in Utah, Minnesota,
and West Virginia to additional satellite bases. The Company expects similar
expansions under two other existing contracts during the second quarter of 2005.
Twelve hospital contracts are due for renewal in 2005. One was renewed for a
5-year term during the first quarter of 2005, and renewals on the remaining
eleven contracts are still pending. The Company expects 2005 flight activity for
continuing hospital contracts to remain consistent with historical levels.
17
Products Division
As of March 31, 2005, the Company was continuing the production of two HH-60L
units for the U.S. Army, a multi-mission interior for the Los Angeles County
Fire Department, and two modular medical interiors for a commercial customer. In
the second quarter of 2005, the Company received a contract for 21 additional
MEV units, plus spare parts, with deliveries scheduled into 2006. Remaining
revenue for all contracts in process as of March 31, 2005, is estimated at $2.3
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 2 currently under contract. The U.S. Army has also forecasted a
requirement for a total of 119 MEV units over 4 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 expects to implement new software for major information technology
systems, including patient billing and inventory tracking, 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 2005. The Company also had approximately $14,285,000
in borrowing capacity available under its revolving credit facility as of March
31, 2005.
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 35% of HBM revenue
is dependent upon flight volume. Approximately 35% of the Company's total
operating expenses also vary with 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.
18
- - Highly leveraged balance sheet - The Company is obligated under debt
facilities providing for up to approximately $97.7 million of indebtedness,
of which approximately $79.3 million was outstanding at March 31, 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 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 to obtain such waivers,
the Company will not be required to pay lenders significant cash or equity
compensation. In May 2005, the Company amended its senior revolving credit
facility which provided funds to retire the subordinated debt. The
restrictive operating covenants under the senior revolving credit facility
are unchanged by the amendment.
- - 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 have continued since early 2004, and a mediator was
appointed in the fourth quarter of 2004 to assist with resolving
differences between the parties. 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 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. 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
19
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.
- - Fuel costs - Fuel accounted for 2.0% of total operating expenses for
the quarter ended March 31, 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 33% 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
20
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 impact of the January accidents on
the Company's hull and liability insurance rates is not yet known. In the
first quarter of 2005, the Company recorded an increase in expense of
$593,000 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 March 31,
2005, 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.
- - 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 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.
- - 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.
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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 CBM flight
revenue for the quarter ended March 31, 2005, a change of 1% in the percentage
of estimated contractual discounts would have resulted in a change of
approximately $633,000 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 CBM net flight revenue for the quarter ended March 31,
2005, a change of 1% in the percentage of estimated uncollectible accounts would
have resulted in a change of approximately $449,000 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.
22
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. The Company is
subject to interest rate risk on its debt obligations and notes receivable, most
of which have fixed interest rates, except $16,556,000 outstanding against the
line of credit and $2,077,000 in notes payable. Based on the amounts outstanding
at March 31, 2005, the annual impact of a 1% change in interest rates would be
approximately $186,000. Interest rates on these instruments approximate current
market rates as of March 31, 2005.
Periodically the Company enters into interest rate risk hedges to minimize
exposure to the effect of an increase in interest rates. As of March 31, 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 $901,000 of
notional principal and receive a floating interest rate (LIBOR plus 2.50%) on
the same amount of notional principal from the counterparty.
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 March 31, 2005, pursuant to Rule
13a-15(b) under the Exchange Act. Based on that evaluation, the Certifying
Officers have concluded that, as of March 31, 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.
23
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
Not Applicable.
ITEM 5. OTHER INFORMATION
Not Applicable.
ITEM 6. 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
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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: May 10, 2005 By \s\ Aaron D. Todd
--------------------------------
Aaron D. Todd
Chief Executive Officer
(Principal Executive Officer)
Date: May 10, 2005 By \s\ Trent J. Carman
--------------------------------
Trent J. Carman
Chief Financial Officer
(Principal Financial Officer)
Date: May 10, 2005 By \s\ Sharon J. Keck
--------------------------------
Sharon J. Keck
Chief Accounting Officer
(Principal Accounting Officer)
25