UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
____________
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 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 (I.R.S. employer
incorporation or organization) identification no.)
7301 SOUTH PEORIA, ENGLEWOOD, COLORADO 80112
(Address of principal executive offices and zip code)
303-792-7400
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
Not Applicable
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $.06 PAR VALUE PER SHARE (THE "COMMON STOCK")
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
--- ---
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates computed by reference to the price at which the common
equity was last sold, or the average bid and asked price of such common equity,
as of the last business day of the registrant's most recently completed second
fiscal quarter: $85,811,000
The number of outstanding shares of Common Stock as of March 1, 2005, was
10,999,997.
TABLE OF CONTENTS
TO FORM 10-K
Page
----
PART I
ITEM 1. BUSINESS . . . . . . . . . . . . . . . . . . . . . . . . . 1
General. . . . . . . . . . . . . . . . . . . . . . . . . . 1
Competition. . . . . . . . . . . . . . . . . . . . . . . . 3
Contracts in Process . . . . . . . . . . . . . . . . . . . 3
Employees. . . . . . . . . . . . . . . . . . . . . . . . . 3
Government Regulation. . . . . . . . . . . . . . . . . . . 4
Internet Address . . . . . . . . . . . . . . . . . . . . . 4
ITEM 2. PROPERTIES . . . . . . . . . . . . . . . . . . . . . . . . 4
Facilities . . . . . . . . . . . . . . . . . . . . . . . . 4
Equipment and Parts. . . . . . . . . . . . . . . . . . . . 5
ITEM 3. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . 6
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. . . . 6
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS. . . . . . . . . . . . . . . . . . . . 7
ITEM 6. SELECTED FINANCIAL DATA. . . . . . . . . . . . . . . . . . 8
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS. . . . . . . . . . . . 10
Overview . . . . . . . . . . . . . . . . . . . . . . . . . 10
Results of Operations. . . . . . . . . . . . . . . . . . . 12
Liquidity and Capital Resources. . . . . . . . . . . . . . 17
Outlook for 2005 . . . . . . . . . . . . . . . . . . . . . 21
Risk Factors . . . . . . . . . . . . . . . . . . . . . . . 22
Critical Accounting Policies . . . . . . . . . . . . . . . 25
New Accounting Standards . . . . . . . . . . . . . . . . . 27
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 27
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. . . . . . . . 27
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE. . . . . . . . . . . . 28
ITEM 9A. CONTROLS AND PROCEDURES. . . . . . . . . . . . . . . . . . 28
ITEM 9B. OTHER INFORMATION. . . . . . . . . . . . . . . . . . . . . 28
i
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. . . . 29
ITEM 11. EXECUTIVE COMPENSATION. . . . . . . . . . . . . . . . . . 32
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT. . . . . . . . . . . . . . . . . . . . . . . . 38
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. . . . . . 41
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. . . . . . . . . . 41
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS AND REPORTS ON FORM 8-K. . IV-1
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . IV-4
ii
PART I
ITEM 1. BUSINESS
GENERAL
Air Methods Corporation, a Delaware corporation (Air Methods or the Company),
was originally incorporated in Colorado in 1982 and now serves as the largest
provider of air medical emergency transport services and systems throughout the
United States of America. The Company provides air medical emergency transport
services under two separate operating models: the Community-Based Model (CBM)
and the Hospital-Based Model (HBM). In October 2002, the Company acquired 100%
of the membership interest of Rocky Mountain Holdings, LLC (RMH), a Delaware
limited liability company which conducts both CBM and HBM operations. As of
December 31, 2004, the Company's CBM division provided air medical
transportation services in 17 states, while its HBM division provided air
medical transportation services to hospitals located in 26 states and Puerto
Rico under operating agreements with original terms ranging from one to ten
years. Under both CBM and HBM operations, the Company transports persons
requiring intensive medical care from either the scene of an accident or general
care hospitals to highly skilled trauma centers or tertiary care centers. The
Company's Products Division designs, manufactures, and installs aircraft medical
interiors and other aerospace or medical transport products. Financial
information for each of the Company's operating segments is included in the
notes to the Company's consolidated financial statements in Item 8 of this
report.
Community-Based Model
CBM services, also referred to as independent provider operations, are performed
by the Company's LifeNet Division and include medical care, aircraft operation
and maintenance, 24-hour communications and dispatch, and medical billing and
collections. CBM aircraft are typically based at fire stations or airports.
Revenue from the CBM consists of flight fees billed directly to patients, their
insurers, or governmental agencies. Due to weather conditions and other factors,
the number of flights is generally higher during the summer months than during
the remainder of the year, causing revenue generated from operations to
fluctuate accordingly.
In July 1997 the Company acquired Mercy Air Service, Inc. (Mercy Air), which has
operated as a community-based provider of air medical transportation services
throughout southern California since 1988. In April 2000, the Company
established a wholly-owned subsidiary, LifeNet, Inc. (formerly ARCH Air Medical
Service, Inc.), to acquire substantially all of the business assets of Area
Rescue Consortium of Hospitals, which has provided air medical transportation
services in the St. Louis metropolitan area and surrounding communities since
1987. Following the acquisition of RMH in October 2002, its CBM operations were
combined with the Company's already existing CBM division. The division operates
78 helicopters and three fixed wing aircraft under both Instrument Flight Rules
(IFR) and Visual Flight Rules (VFR) in 17 states, with concentrations in
California, Arizona, the Midwest, and the Southeast. Although the division does
not generally contract directly with specific hospitals, it has long-standing
relationships with several leading healthcare institutions in the metropolitan
areas in which it operates.
Communications and dispatch operations for all CBM locations are conducted from
the Company's national center in Omaha, Nebraska, or from the regional center in
St. Louis, Missouri. Medical billing and collections are processed from the
Company's offices in San Bernardino, California, and Bountiful, Utah.
In 2004 the Company opened seven new CBM locations throughout the U.S. and
closed two locations in the Southeast due to low flight volume and low
collection rates.
1
Hospital-Based Model
The Company's HBM provides hospital clients with medically-equipped helicopters
and airplanes which are generally based at hospitals. The Company's
responsibility is to operate and maintain the aircraft in accordance with
Federal Aviation Regulations (FAR) Part 135 standards. Hospital clients provide
medical personnel and all medical care on board the aircraft. The division
operates 91 helicopters and 13 fixed wing aircraft in 26 states plus Puerto
Rico. Under the typical operating agreement with a hospital, the Company earns
approximately 65% of its revenue from a fixed monthly fee and 35% from an hourly
flight fee from the hospital, regardless of when, or if, the hospital is
reimbursed for these services by its patients, their insurers, or the federal
government. Both monthly and hourly fees are generally subject to annual
increases based on changes in the consumer price index, hull and liability
insurance premiums, or spare parts prices from aircraft manufacturers. Because
the majority of the division's flight revenue is generated from fixed monthly
fees, seasonal fluctuations in flight hours do not significantly impact monthly
revenue in total.
The HBM operations of RMH were integrated into the division following the
acquisition in October 2002. In the first quarter of 2004, the Company began
operations under a five-year contract with a new customer in Florida and
discontinued operations under a contract in New Mexico. The Company expanded a
contract in Missouri to a satellite location during the second quarter of 2004
and expanded contracts in Colorado and North Carolina to satellite locations
during the fourth quarter of 2004.
The Company operates some of its HBM contracts under the service mark AIR
LIFE(R), which is generally associated within the industry with the Company's
standard of service.
Technical Services
The Company's technical services group performs non-destructive component
testing, engine repair, and component overhaul at its headquarters in
metropolitan Denver, Colorado, for both CBM and HBM divisions. The Company is a
Customer Service Facility for Bell Helicopter, Inc. (Bell) and an FAA-Certified
Repair Station authorized to perform airframe, avionics, and limited engine
repairs. In-house repair, maintenance, and testing capabilities provide cost
savings and decrease aircraft down time by avoiding the expense and delay of
having this work performed by nonaffiliated vendors. The technical services
group also provides spare parts procurement and inventory and aircraft
recordkeeping services for the majority of the Company's flight operations.
Products Division
The Company's Products Division designs, manufactures, and certifies modular
medical interiors, multi-mission interiors, and other aerospace and medical
transport products. These interiors and other products range from basic life
support to intensive care suites to advanced search and rescue systems. The
modular design provides for flexibility of configuration for multiple transport
needs and optimizes space, weight, cost, and maintainability. With a full range
of engineering, manufacturing and certification capabilities, the division has
also designed and integrated aircraft communication and navigation systems,
environmental control systems, and structural and electrical systems.
Manufacturing capabilities include avionics, electrical, composites, machining,
welding, sheetmetal, and upholstery. The division also offers quality assurance
and certification services pursuant to Parts Manufacturer Approvals (PMA's) and
maintains ISO9001:2000 (Quality Systems) certification.
The Company maintains patents covering several products, including the Litter
Lift System, used in the U.S. Army's HH60L helicopter and in the Medical
Evacuation Vehicle (MEV), and the Articulating Patient Loading System and
Modular Equipment Frame, which were developed as part of the modular interior
concept. Raw materials and components used in the manufacture of interiors and
other products are generally widely available from several different vendors.
2
During 2004, the Company completed 21 MEV litter systems and continued
production of 19 additional MEV units and 13 HH-60L Multi-Mission Medevac
Systems for the U.S. Army, with delivery to be completed in 2005. The Company
also continued to support both the HH60L and MEV programs with the production of
spare parts and research of product enhancements. In the second quarter of 2004
the Company began production of a multi-mission interior for a FIREHAWK
helicopter for the Los Angeles County Fire Department; completion is expected in
the first half of 2005. Work on two modular medical interiors for a commercial
customer was also commenced in the fourth quarter of 2004.
COMPETITION
Competition in the air medical transportation industry comes primarily from
three national operators: CJ Systems, Inc.; OmniFlight, Inc.; and Petroleum
Helicopters, Inc. The CBM also faces competition from smaller regional carriers
and alternative air ambulance providers such as local governmental entities.
Operators generally compete on the basis of price, safety record, accident
prevention and training, and the medical capability of the aircraft. Price is a
significant element of competition for HBM operations as many healthcare
organizations continue to move toward consolidation and strict cost containment.
The Company believes that its competitive strengths center on the quality of its
customer service and the medical capability of the aircraft it deploys, as well
as its ability to tailor the service delivery model to a hospital's or
community's specific needs.
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. With the development of a
line of interiors for Eurocopter aircraft to complement its established line of
interiors for Bell aircraft, the Company believes that it has demonstrated the
ability to compete on the basis of each of these factors.
CONTRACTS IN PROCESS
As of December 31, 2004, the Company had the following projects in process:
- Thirteen HH-60L units and nineteen MEV units for the U.S. Army.
Eleven of the HH60L units were nearly complete as of December 31,
2004.
- Multi-mission interior for Los Angeles County FIREHAWK helicopter
- Two modular medical interiors for a commercial customer
Deliveries under all contracts in process as of December 31, 2004, are expected
to be completed by the second quarter of 2005, and remaining revenue is
estimated at $2.1 million. As of December 31, 2003, the revenue remaining to be
recognized on medical interiors and other products in process was estimated at
$3.1 million.
EMPLOYEES
As of December 31, 2004, the Company had 1,623 full time and 210 part time
employees, comprised of 627 pilots; 348 aviation machinists, airframe and power
plant (A&P) engineers, and other manufacturing/maintenance positions; 525 flight
nurses and paramedics; and 333 business and administrative personnel. The
Company's pilots are IFR-rated where required by contract, and all have
completed an extensive ground school and flight training program at the
commencement of their employment with the Company, as well as local area
orientation and annual training provided by the Company. All of the Company's
aircraft mechanics must possess FAA A&P licenses. All flight nurses and
paramedics hold the appropriate state and county licenses, as well as
Cardiopulmonary Resuscitation, Advanced Cardiac Life Support, and/or Pediatric
Advanced Life Support certifications.
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.
3
GOVERNMENT REGULATION
The Company is subject to the Federal Aviation Act of 1958, as amended. All
flight and maintenance operations of the Company are regulated and actively
supervised by the U.S. Department of Transportation through the FAA. Medical
interiors and other aerospace products developed by the Company are subject to
FAA certification. Air Methods and LifeNet, Inc. each hold a Part 135 Air
Carrier Certificate, and Air Methods, Mercy, and LifeNet, Inc. each hold a Part
145 Repair Station Certificate from the FAA. A Part 135 certificate requires
that the voting interests of the holder of the certificate cannot be more than
25% owned by foreign persons. As of December 31, 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.
The Company is also subject to laws, regulations, and standards relating to
corporate governance and public disclosure, including the Sarbanes-Oxley Act of
2002, Securities and Exchange Commission regulations, and NASDAQ National Market
rules.
INTERNET ADDRESS
The Company's internet site is www.airmethods.com. The Company makes available
------------------
free of charge, on or through the website, all annual, quarterly, and current
reports, as well as any amendments to these reports, as soon as reasonably
practicable after electronically filing these reports with the Securities and
Exchange Commission. This reference to the website does not incorporate by
reference the information contained in the website and such information should
not be considered a part of this report.
ITEM 2. PROPERTIES
FACILITIES
The Company leases its headquarters, consisting of approximately 88,500 square
feet of office and hangar space, in metropolitan Denver, Colorado, at Centennial
Airport. The lease expires in August 2006 and the approximate annual rent is
$980,000. CBM Division headquarters consist of approximately 50,000 square feet
of office and hangar space owned by the Company in Rialto, California. Under a
ground lease which expires in May 2007, the Company pays minimal rent for the
land at the airport where the facilities are located. The Company also owns and
leases various properties for depot level maintenance and administration
purposes. The Company believes that these facilities are in good condition and
suitable for the Company's present requirements.
4
EQUIPMENT AND PARTS
As of December 31, 2004, the Company managed and operated a fleet of 185
aircraft, composed of the following:
Number of Number of Number of
Company-Owned Company-Leased Customer-
Type Aircraft Aircraft Owned Aircraft Total
- ---------------------------------------------------------------------------
Helicopters:
Bell 206 5 -- -- 5
Bell 222 13 9 -- 22
Bell 230 -- -- 2 2
Bell 407 5 9 5 19
Bell 412 4 3 2 9
Bell 430 -- 2 1 3
Eurocopter AS 350 17 21 3 41
Eurocopter AS 355 1 -- -- 1
Eurocopter BK 117 16 25 -- 41
Eurocopter BO 105 2 3 1 6
Eurocopter EC 130 -- 4 -- 4
Eurocopter EC 135 -- 7 3 10
Eurocopter EC 145 -- -- 3 3
Boeing MD 902 -- 2 -- 2
Sikorsky S 76 -- -- 1 1
----------------------------------------------------
63 85 21 169
----------------------------------------------------
Airplanes:
King Air E 90 1 -- 4 5
King Air B 100 -- 2 -- 2
King Air B 200 1 -- 2 3
Pilatus PC 12 -- 2 4 6
----------------------------------------------------
2 4 10 16
----------------------------------------------------
TOTALS 65 89 31 185
====================================================
The Company generally pays all insurance, taxes, and maintenance expense for
each aircraft in its fleet. Because helicopters are insured at replacement cost
which usually exceeds book value, the Company believes that helicopter accidents
covered by hull and liability insurance will generally result in full
reimbursement of any damages sustained. In the ordinary course of business, the
Company may from time to time purchase and sell helicopters in order to best
meet the specific needs of its operations.
The Company has experienced no significant difficulties in obtaining required
parts for its helicopters. Repair and replacement components are purchased
primarily through Bell and American Eurocopter Corporation (AEC), since Bell and
Eurocopter aircraft make up the majority of the Company's fleet. Based upon the
manufacturing capabilities and industry contacts of Bell and AEC, the Company
believes it will not be subject to material interruptions or delays in obtaining
aircraft parts and components. Any termination of production by Bell or AEC
would require the Company to obtain spare parts from other suppliers, which are
not currently in place.
5
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter ended
December 31, 2004.
6
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the NASDAQ National Market System under
the trading symbol "AIRM." The following table shows, for the periods indicated,
the high and low closing prices for the Company's common stock. The quotations
for the common stock represent prices between dealers and do not reflect
adjustments for retail mark-ups, mark-downs or commissions, and may not
represent actual transactions.
YEAR ENDED DECEMBER 31, 2004
----------------------------
Common Stock High Low
- ------------------------------------------
First Quarter . . . . . . . . $9.33 $8.45
Second Quarter. . . . . . . . 9.20 7.80
Third Quarter . . . . . . . . 8.88 6.22
Fourth Quarter. . . . . . . . 8.66 6.65
YEAR ENDED DECEMBER 31, 2003
----------------------------
Common Stock High Low
- ------------------------------------------
First Quarter . . . . . . . . $6.66 $5.32
Second Quarter. . . . . . . . 8.19 5.72
Third Quarter . . . . . . . . 8.88 6.83
Fourth Quarter. . . . . . . . 9.69 8.16
As of March 1, 2005, there were approximately 316 holders of record of the
Company's common stock. The Company estimates that it has approximately 3,900
beneficial owners of common stock.
The Company has not paid any cash dividends since its inception and intends to
retain any future earnings to finance the growth of the Company's business
rather than to pay dividends.
7
ITEM 6. SELECTED FINANCIAL DATA
The following tables present selected consolidated financial information of the
Company and its subsidiaries which has been derived from the Company's audited
consolidated financial statements. This selected financial data should be read
in conjunction with the consolidated financial statements of the Company and
notes thereto appearing in Item 8 of this report. Revenue, expenses, assets, and
long-term liabilities as of and for the years ended December 31, 2004, 2003, and
2002, increased in part as a result of the acquisition of RMH in October 2002.
See "Business - General" in Item 1 and "Management's Discussion and Analysis" in
Item 7 of this report.
SELECTED FINANCIAL DATA OF THE COMPANY
(Amounts in thousands except share and per share amounts)
Year Ended December 31,
-----------------------
2004 2003 2002 2001 2000
-------------------------------------------------------------
STATEMENT OF OPERATIONS DATA:
Revenue $ 273,103 242,455 130,668 92,096 75,293
Operating expenses:
Operating 232,400 205,342 106,771 74,597 61,393
General and administrative 28,641 21,550 12,744 9,781 7,854
Other income (expense), net (6,698) (7,197) (2,694) (1,770) (1,889)
-------------------------------------------------------------
Income before income taxes 5,364 8,366 8,459 5,948 4,157
Income tax benefit (expense) (2,121) (3,263) (3,299) 615 -
-------------------------------------------------------------
Income before cumulative effect of change in
accounting principle 3,243 5,103 5,160 6,563 4,157
Cumulative effect of change in method of
accounting for maintenance costs, net of
income taxes 8,595 - - - -
-------------------------------------------------------------
Net income $ 11,838 5,103 5,160 6,563 4,157
=============================================================
Basic income per common share:
Income before cumulative effect of change
in accounting principle $ .30 .53 .56 .78 .50
Cumulative effect of change in method of
accounting for maintenance costs, net of
income taxes .79 - - - -
-------------------------------------------------------------
Net income $ 1.09 .53 .56 .78 .50
=============================================================
Diluted income per common share:
Income before cumulative effect of change
in accounting principle $ .29 .51 .54 .76 .49
Cumulative effect of change in method of
accounting for maintenance costs, net of
income taxes .76 - - - -
-------------------------------------------------------------
Net income $ 1.05 .51 .54 .76 .49
=============================================================
Weighted average number of shares
of Common Stock outstanding - basic 10,894,863 9,665,278 9,184,421 8,421,671 8,334,445
=============================================================
Weighted average number of shares
of Common Stock outstanding - diluted 11,314,827 10,052,989 9,478,502 8,659,302 8,559,389
=============================================================
8
SELECTED FINANCIAL DATA OF THE COMPANY
(Amounts in thousands except share and per share amounts)
As of December 31,
------------------------------------------
2004 2003 2002 2001 2000
------------------------------------------
BALANCE SHEET DATA:
Total assets $204,723 215,649 196,396 85,557 75,250
Long-term liabilities 89,490 114,657 115,225 34,210 29,885
Stockholders' equity 73,079 60,688 46,218 36,543 29,416
SELECTED OPERATING DATA
2004 2003 2002 2001 2000
--------------------------------------
FOR YEAR ENDED DECEMBER 31:
CBM patient transports 30,159 25,676 12,870 9,212 7,091
HBM medical missions 46,630 46,570 26,367 19,073 17,484
AS OF DECEMBER 31:
CBM bases 64 59 48 17 16
HBM contracts 44 43 47 22 22
9
ITEM 7. 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 8 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
the Business section of this report, 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 quarterly reports on Form 10-Q. 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 and medical transport products. 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 2004 the CBM Division generated 65% of
the Company's total revenue, increasing from 60% in 2003 and 56% in 2002.
- - 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 2004 the HBM Division
generated 33% of the Company's total revenue, decreasing from 36% in 2003
and 39% in 2002.
- - 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 2% of the Company's total revenue, decreasing from 3% in 2003 and
4% in 2002.
See Note 13 to the consolidated financial statements included in Item 8 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, 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 variable 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 30,200 for 2004 compared
to approximately 25,700 for 2003. Patient transports for CBM bases open
longer than one year (Same-Base Transports) were approximately 25,600 in
2004 compared to approximately 24,600 in 2003.
10
- - 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 5% effective January
2004 and an additional 10% effective September 2004. However, net revenue
after bad debt expense per transport increased only 0.5% from 2003 to 2004.
Generally, price increases result in incremental revenue from privately
insured patients only. Bad debt expense as a percentage of related net
flight revenue increased from 22.2% in 2003 to 24.1% in 2004. The Company
believes the decrease in collection rate is driven primarily by overall
economic conditions. In an effort to increase its collection rates, the
Company increased staffing in the billing and collections department,
segmented billing by region, and hired a national billing director in 2004.
- - 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 28% of the 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, as adjusted for the change in accounting method
described below, increased 15.4% from 2003 to 2004, while total flight
volume for CBM and HBM operations increased 7.0% 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. As described more fully below in Liquidity and
Capital Resources, 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.
- - 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. At the expiration of the
contract in the first quarter of 2004, one HBM customer also converted its
flight program 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 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 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.
11
RESULTS OF OPERATIONS
Year ended December 31, 2004 compared to 2003
The Company reported net income of $11,838,000 for the year ended December 31,
2004, compared to $5,103,000 for the year ended December 31, 2003. Net income
for the year ended December 31, 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 $3,243,000 for 2004. An increase in flight volume during the year
was offset in part by increased aircraft maintenance costs and bad debt expense.
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).
In 2002, the impact of the major overhaul accrual relating to aircraft purchased
in the 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.
Pro forma results, assuming the change in accounting principle had been applied
retroactively, are as follows for the year ended December 31, 2003 (amounts in
thousands):
As Reported Pro Forma
-----------------------
Aircraft operations expense $ 56,776 52,430
=======================
Depreciation and amortization $ 11,309 9,797
=======================
Net income $ 5,103 8,676
=======================
Basic income per share $ .53 .90
=======================
Diluted income per share $ .51 .86
=======================
FLIGHT OPERATIONS - COMMUNITY-BASED MODEL AND HOSPITAL-BASED MODEL
FLIGHT REVENUE increased $31,010,000, or 13.2%, from $234,687,000 for the year
ended December 31, 2003, to $265,697,000 for the year ended December 31, 2004.
Flight revenue is generated by both HBM and CBM operations and is recorded net
of contractual allowances under agreements with third-party payers (i.e.,
Medicare and Medicaid).
- - CBM - Flight revenue increased $30,542,000, or 20.9%, to $176,867,000
for the following reasons:
- Incremental revenue of $22,324,000 generated from the addition of
17 new CBM bases during either 2003 or 2004.
12
- 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 91.6% during the first four months
of 2004 compared to the same period in 2003, resulting in incremental
revenue of approximately $2,508,000.
- 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 $3,293,000.
- Increase in Same Base Transports. Excluding the impact of the new
bases and base closures discussed above, total flight volume for all
CBM operations increased 4.1% in 2004, primarily attributable to
improved weather conditions and an increase in flight requests, driven
in part by enhanced crew outreach and other marketing initiatives.
- 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. See discussion of
total provision for uncollectible accounts, including contractual
discounts and bad debt expense, below under "Bad Debt Expense."
- - HBM - Flight revenue increased $469,000, or 0.5%, to $88,831,000 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 $5,356,000.
- Revenue of $2,859,000 generated by the addition of one new
contract during the first quarter and the expansion of three contracts
in the second and fourth quarters of 2004.
- Annual price increases in the majority of contracts based on
changes in the Consumer Price Index.
- Increase of 3.3% in flight volume for all contracts, excluding
the discontinued contracts and new contracts discussed above.
FLIGHT CENTER COSTS (consisting primarily of pilot, mechanic, and medical staff
salaries and benefits) increased $13,309,000, or 15.3%, to $100,460,000 for the
year ended December 31, 2004, compared to 2003. Changes by business segment are
as follows:
- - CBM - Flight center costs increased $12,615,000, or 23.7%, to
$65,916,000 for the following reasons:
- Increase of $10,524,000 for the addition of personnel and
facilities for the new base locations described above.
- Decrease of $1,650,000 due to the closure of base locations
described above.
- Increases in salaries for merit pay raises.
- Increase of approximately $700,000 for telecommunications costs
associated with dispatch operations.
- - HBM - Flight center costs increased $694,000, or 2.1%, to $34,544,000
primarily due to the following:
- Decrease of $2,067,000 due to the closure of base locations
described above.
- Increase of $1,252,000 for the addition of personnel and
facilities for the new base locations described above.
- Increases in salaries for merit pay raises.
AIRCRAFT OPERATING EXPENSES increased $3,140,000, or 5.5%, for the year ended
December 31, 2004, in comparison to 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 18 helicopters for CBM operations and 15 for HBM
operations during either 2003 or 2004. The resulting incremental impact for
2004 was an increase of approximately $2,723,000.
- - 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 compared to 2003.
- - Increase of approximately 12.8% in the cost of aircraft fuel per hour
flown.
- - Decrease in hull insurance rates effective July 2004.
AIRCRAFT RENTAL EXPENSE increased $3,230,000, or 27.3%, for the year ended
December 31, 2004, in comparison to the year ended December 31, 2003.
Incremental rental expense incurred in 2004 for 26 leased aircraft added to the
Company's fleet during either 2003 or 2004 totaled $3,639,000.
13
BAD DEBT EXPENSE increased $10,373,000, or 31.9%, for the year ended December
31, 2004, compared to 2003, due in part to the increase in related flight
revenue. In addition, bad debt expense as a percentage of related net flight
revenue was 24.1% in 2004, compared to 22.2% in 2003. Flight revenue is recorded
net of Medicare/Medicaid discounts. The total reserve for expected uncollectible
amounts, including contractual discounts and bad debts, increased from 43.6% of
related gross flight revenue for 2003 to 48.1% for 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, as well as the dilutive effect of price increases
on collection rates. Bad debt expense related to HBM operations and Products
Division was not significant in either 2004 or 2003.
MEDICAL INTERIORS AND PRODUCTS
SALES OF MEDICAL INTERIORS AND PRODUCTS increased $497,000, or 7.3%, from
$6,803,000 for the year ended December 31, 2003, to $7,300,000 for the year
ended December 31, 2004. Significant projects in 2004 included production of 13
Multi-Mission Medevac Systems for the U. S. Army's HH-60L Black Hawk helicopter,
40 MEV litter systems, a multi-mission interior for a Sikorsky FIREHAWK
helicopter for the Los Angeles County Fire Department, and four modular medical
interiors for three commercial customers. Revenue by product line for the year
ended December 31, 2004, was as follows:
- - $811,000 - manufacture and installation of modular medical
interiors
- - $4,244,000 - manufacture of multi-mission interiors
- - $2,245,000 - design and manufacture of other aerospace and medical
transport products
Significant projects in 2003 included the manufacture of eight modular medical
interiors for four commercial customers and eleven HH60L Multi-Mission Medevac
Systems. Revenue by product line for the year ended December 31, 2003, was as
follows:
- - $2,927,000 - manufacture and installation of modular medical interiors
- - $2,782,000 - manufacture of multi-mission interiors
- - $1,094,000 - design and manufacture of other aerospace and medical
transport products
COST OF MEDICAL INTERIORS AND PRODUCTS decreased $2,052,000, or 43.1%, for the
year ended December 31, 2004, as compared to the previous year. The average net
margin earned on projects during 2004 was 44% compared to 24% 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 $326,000, or 2.9%, for the year
ended December 31, 2004, primarily due to 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 $1,512,000 in
depreciation expense in 2004. The decrease was offset in part by depreciation on
engine upgrades, medical interior and avionics upgrades, an upgraded flight
tracking system, and computer hardware and software placed into service in 2004.
GENERAL AND ADMINISTRATIVE (G&A) EXPENSES increased $7,091,000, or 32.9%, for
the year ended December 31, 2004, compared to the year ended December 31, 2003,
reflecting the growth in the Company's operations. G&A expenses include
accounting and finance, billing and collections, human resources, aviation
management, pilot training, and CBM program administration. G&A expenses were
10.5% of revenue for 2004, compared to 8.9% for 2003. 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
14
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
personnel in 2004 to keep pace with the growth in CBM operations and to address
a slowdown in collections in early 2004. During 2004, the Company also incurred
approximately $1,178,000 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. 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 $396,000, or 4.8%, for the year ended December 31,
2004, compared to 2003, due to 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 Company recorded INCOME TAX EXPENSE of $2,121,000 in 2004 and $3,263,000 in
2003, both at an effective rate of approximately 39%. For income tax purposes,
at December 31, 2004, the Company has net operating loss carryforwards (NOL's)
of approximately $23 million, expiring at various dates through 2024. During
2004, NOL's of $4.2 million, for which a valuation allowance had previously been
established, expired. As of December 31, 2004, a valuation allowance has been
provided for NOL's which are not expected to be realized prior to expiration.
Based on management's assessment, realization of net deferred tax assets through
future taxable earnings is considered more likely than not, except to the extent
valuation allowances are provided.
Year ended December 31, 2003 compared to 2002
The Company reported net income of $5,103,000 and income before income taxes of
$8,366,000 for the year ended December 31, 2003, compared to $5,160,000 and
$8,459,000, respectively, for the year ended December 31, 2002. Results for 2003
included twelve months of RMH operations, while 2002 results included only two
and a half months of RMH operations from the acquisition date of October 16,
2002, through the end of the year. Total revenue increased $111,787,000, or
85.6%, in 2003 compared to 2002, primarily due to the RMH acquisition and to the
addition of ten new CBM bases during the year. Because the Company has a high
level of fixed costs, the slight decrease in net income from 2002 to 2003 was
principally attributed to a decrease in flight volume caused by adverse weather
conditions and a decline in collection rates on CBM operations, as discussed
more thoroughly below.
FLIGHT OPERATIONS - COMMUNITY-BASED MODEL AND HOSPITAL-BASED MODEL
FLIGHT REVENUE increased $111,153,000, or 90.0%, from $123,534,000 for the year
ended December 31, 2002, to $234,687,000 for the year ended December 31, 2003.
- - CBM - Flight revenue increased $74,204,000, or 102.9%, to
$146,325,000. Total patient transports were approximately 25,700 for 2003
compared to approximately 12,900 for 2002. The increase in flight revenue
was due to the following:
- Acquisition of RMH in October 2002. Flight revenue for RMH CBM
operations totaled $80,793,000 for 2003 compared to $14,750,000 from
the acquisition date through December 31, 2002.
- Revenue of $11,601,000 from the addition of ten new CBM bases
throughout 2003 and one new base in the second quarter of 2002.
- Price increase of approximately 10% for all CBM operations
effective November 1, 2002.
- Decrease in flight volume for bases open longer than one year.
Excluding the impact of the RMH acquisition and the addition of the
new bases discussed above, total flight volume for CBM operations
decreased 2.1% in 2003, compared to the prior year. The decrease in
flight volume is primarily attributed to adverse weather conditions in
the first half of 2003 which prevented operation of the aircraft.
- - HBM - Flight revenue increased $36,949,000, or 71.9%, to $88,362,000
for the following reasons:
- Acquisition of RMH. Flight revenue for RMH's HBM operations
totaled $44,089,000 for 2003 compared to $8,946,000 from the
acquisition date through December 31, 2002.
- Incremental revenue of approximately $939,000 generated in 2003
by the addition of one new contract in the second quarter of 2002 and
one in the third quarter of 2002.
- Annual price increases in the majority of contracts based on
changes in the Consumer Price Index.
- Flight volume for all contracts, excluding RMH contracts and the
new contracts discussed above, decreased 2.0% for 2003 compared to the
prior year.
15
FLIGHT CENTER COSTS increased $44,193,000, or 102.9%, to $87,151,000 for the
year ended December 31, 2003, compared to 2002. Changes by business segment are
as follows:
- - CBM - Flight center costs increased $30,208,000, or 130.8%, to
$53,301,000 for the following reasons:
- Acquisition of RMH. Flight center costs related to RMH CBM
operations totaled approximately $28,868,000 in 2003 compared to
$5,108,000 from the acquisition date through December 31, 2002.
- Approximately $5,147,000 for the addition of personnel and
facilities for the new base locations described above.
- Increases in salaries for merit pay raises.
- Increases in the cost of medical and workers compensation
insurance premiums paid by the Company.
- - HBM - Flight center costs increased $13,985,000, or 70.4%, to $33,850,000
primarily due to the following:
- Acquisition of RMH. Flight center costs related to RMH HBM
operations totaled approximately $16,073,000 for 2003 compared to
$2,964,000 from the acquisition date through December 31, 2002.
- Incremental costs of $347,000 in 2003 for the addition of
personnel and facilities for the new base locations described above.
- Increases in salaries for merit pay raises.
AIRCRAFT OPERATING EXPENSES increased $27,005,000, or 90.7%, for the year ended
December 31, 2003, in comparison to 2002. The increase in costs is due to the
following:
- - Acquisition of RMH. Expenses for the RMH fleet totaled $25,009,000 for
the year ended December 31, 2003, compared to $4,317,000 from the
acquisition date through December 31, 2002.
- - Addition of eleven aircraft for CBM operations and three aircraft for
HBM operations in late 2002 or in 2003, resulting in an increase of
approximately $1,791,000 for the year ended December 31, 2003.
- - Addition of personnel in aircraft overhaul, avionics repair,
purchasing, and aircraft records departments to support the increase in the
size of the fleet resulting from the RMH acquisition.
- - Decrease of approximately 15% in hull insurance rates effective July
2003.
- - Annual price increases in the cost of spare parts and overhauls.
AIRCRAFT RENTAL EXPENSE increased $5,668,000, or 91.8%, for the year ended
December 31, 2003, in comparison to the year ended December 31, 2002. Expense
for RMH aircraft under operating leases totaled $6,174,000 for the year ended
December 31, 2003, compared to $1,185,000 from the acquisition date through
December 31, 2002. Rental expense related to 11 other leased aircraft added to
the Company's fleet totaled $903,000 for the year ended December 31, 2003.
BAD DEBT EXPENSE increased $16,933,000, or 108.6%, for the year ended December
31, 2003, compared to 2002, due primarily to the acquisition of RMH. Bad debt
related to RMH CBM operations totaled $20,702,000 for the year ended December
31, 2003, compared to $4,829,000 from the date of acquisition through December
31, 2002. Bad debt expense as a percentage of related net flight revenue
increased from 21.6% in 2002 to 22.2% in 2003. Flight revenue is recorded net of
Medicare/Medicaid discounts. The total allowance for expected uncollectible
amounts, including contractual discounts and bad debts, increased from 37.6% of
related gross flight revenue for the year ended December 31, 2002, to 43.6% in
the year ended December 31, 2003. The increase in total allowances is related
primarily to the acquisition of RMH, whose collection experience had
historically been less favorable than other CBM operations owned by the Company,
and to a decrease in the collection rate for other CBM operations. The Company
believes the decrease in collection rates is also due to general recessionary
trends in the economy. Bad debt expense related to HBM operations and Products
Division was not significant in either 2003 or 2002.
MEDICAL INTERIORS AND PRODUCTS
SALES OF MEDICAL INTERIORS AND PRODUCTS increased $1,007,000, or 17.4%, from
$5,796,000 for the year ended December 31, 2002, to $6,803,000 for the year
ended December 31, 2003. Significant projects in 2003 included the manufacture
of eight modular medical interiors for four commercial customers and eleven
HH60L Multi-Mission Medevac Systems. Revenue by product line for the year ended
December 31, 2003, was as follows:
- - $2,927,000 - manufacture and installation of modular medical
interiors
- - $2,782,000 - manufacture of multi-mission interiors
- - $1,094,000 - design and manufacture of other aerospace and medical
transport products
16
Significant projects in 2002 included the completion of five HH-60L
Multi-Mission Medevac Systems and development of the MEV litter system, both for
the U.S. Army, and the manufacture of medical interiors or modular interior
components for six commercial customers. Revenue by product line for the year
ended December 31, 2002, was as follows:
- - $2,452,000 - manufacture and installation of modular medical interiors
- - $808,000 - manufacture of multi-mission interiors
- - $2,536,000 - design and manufacture of other aerospace and medical
transport products
COST OF MEDICAL INTERIORS AND PRODUCTS increased by 11.4% for the year ended
December 31, 2003, as compared to the previous year, reflecting the change in
sales volume over the same period. The 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 $4,614,000, or 68.9%, for the
year ended December 31, 2003. Depreciation related to assets added as part of
the RMH acquisition totaled $4,915,000 for the year ended December 31, 2003,
compared to $983,000 from the date of the acquisition through December 31, 2002.
The remainder of the increase for the year is related to the purchase of rotable
and other equipment to support the expanded fleet and new bases of operation, as
well as the refurbishment of medical interiors for existing aircraft.
GENERAL AND ADMINISTRATIVE EXPENSES increased $8,806,000, or 69.1%, for the year
ended December 31, 2003, compared to the year ended December 31, 2002,
reflecting the impact of the RMH transaction. On average, the Company doubled
the number of personnel in each area to manage the expanded operations with the
acquisition of RMH and the growth outlined above in the discussion of flight
revenue. Also included in general and administrative expenses are program
administration costs for CBM operations. Program administration costs for RMH's
CBM operations totaled $3,094,000 for the year ended December 31, 2003.
INTEREST EXPENSE increased $5,204,000, or 170.7%, for the year ended December
31, 2003, compared to 2002, primarily as a result of the RMH acquisition.
Interest expense related to debt assumed or incurred in conjunction with the RMH
acquisition totaled $6,847,000 for the year ended December 31, 2003, compared to
$1,303,000 from the acquisition date through December 31, 2002.
The Company recorded INCOME TAX EXPENSE of $3,263,000 in 2003 and $3,299,000 in
2002, both at an effective rate of 39%.
LIQUIDITY AND CAPITAL RESOURCES
The Company had working capital of $48,849,000 as of December 31, 2004, compared
to $43,682,000 at December 31, 2003. The change in working capital position is
primarily attributable to the following:
- - Increase of $3,070,000 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 $4,387,000 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 long-term component.
17
CASH REQUIREMENTS
Debt and Other Long-term Obligations
The following table outlines the Company's contractual obligations as of
December 31, 2004 (amounts in thousands):
Less than 1 After 5
Total year 1-3 years 4-5 years years
-------------------------------------------------------
Long-term debt $ 95,017 12,020 61,719 18,845 2,433
Less: interest payments (1) 16,283 5,979 8,998 1,251 55
-------------------------------------------------------
Principal payments 78,734 6,041 52,721 17,594 2,378
-------------------------------------------------------
Capital leases 722 454 268 -- --
Less: interest (63) (44) (19) -- --
-------------------------------------------------------
Net present value 659 410 249 -- --
-------------------------------------------------------
Operating leases 112,649 18,232 33,828 28,763 31,826
Aircraft purchase commitments 72,290 11,915 15,975 22,200 22,200
-------------------------------------------------------
Total $264,332 36,598 102,773 68,557 56,404
=======================================================
(1) Interest payments include an estimate of variable-rate interest on the
Company's senior revolving credit facility and two notes with principal
balances totaling $2,127,000 as of December 31, 2004. Variable interest was
estimated using the weighted average rate in effect as of December 31,
2004, for each note and the weighted average balance outstanding against
the revolving credit facility during 2004.
Repayment of debt and capital lease obligations as well as operating lease
agreements constitute the Company's primary long-term commitments to use cash.
Balloon payments on long-term debt are due as follows:
- $17,468,000 in 2006
- $23,997,000 in 2007
- $7,414,000 in 2008
- $1,918,000 in 2009
- $772,000 in 2010
OFF-BALANCE SHEET ARRANGEMENTS
Residual Value Guarantees
The Company has entered into various aircraft operating leases under which it
provides residual value guarantees to the lessor. As of December 31, 2004, the
undiscounted maximum amount of potential future payments under the guarantees is
$3,648,000. No amounts have been accrued for any estimated losses with respect
to the guarantees, since it is not probable that the residual value of the
aircraft will be less than the amounts stipulated in the guarantee. The
assessment of whether it is probable that the Company will be required to make
payments under the terms of the guarantee is based on current market data and
the Company's actual and expected loss experience.
Aircraft Purchase Commitments
Prior to acquisition by the Company, RMH entered into a commitment agreement to
take delivery of eight aircraft for approximately $16,000,000. As of December
31, 2004, the Company had taken delivery of all aircraft under the agreement.
18
Prior to the acquisition, RMH entered into a commitment agreement to take
delivery of ten aircraft for approximately $16,600,000. As of December 31, 2004,
four aircraft with a total value of approximately $6,500,000 remained to be
delivered and the deposit and related note payable associated with this
commitment totaled $347,000.
In March 2004, the Company entered into a commitment agreement to purchase 10
Eurocopter EC135 helicopters for approximately $34,300,000, with deliveries
scheduled through the first quarter of 2005. As of December 31, 2004, the
Company had taken delivery of seven helicopters under the agreement.
In July 2004, the Company entered into a commitment agreement to purchase 15
Bell 427 helicopters for approximately $55,500,000, 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 fifteen 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. Typically the Company has financed aircraft acquired
under these or similar commitments through operating lease agreements.
Letter of Credit
In August 2004, the Company entered into a $1,208,000 letter of credit with a
financial institution to securitize an aircraft leased by the Company under an
operating lease agreement. Because the aircraft is operated in Puerto Rico, the
lessor is unable to perfect its security interest against the aircraft. The
letter of credit perpetually renews for consecutive one-year terms through the
end of the lease agreement in July 2010 or until the aircraft is moved from
Puerto Rico and reduces the available borrowing capacity under the Company's
senior revolving credit facility described below.
SOURCES AND USES OF CASH
The Company had cash and cash equivalents of $2,603,000 at December 31, 2004,
compared to $5,574,000 at December 31, 2003. Cash generated by operations
increased to $15,381,000 in 2004 from $4,403,000 in 2003. Receivable balances,
net of bad debt expense, increased $3,070,000 in 2004 compared to $21,436,000 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 $135.7
million in 2004, compared to $92.8 million in 2003.
Cash used for investing activities totaled $11,893,000 in 2004, compared to
$8,197,000 in 2003. Equipment acquisitions in 2004 consisted primarily of
medical interior and avionics installations, information systems hardware and
software, and rotable equipment. In 2004 the Company received $1,600,000 from
the sale of two of its aircraft and approximately $1,300,000 from the refund of
deposits for the purchase of 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, and rotable equipment.
Financing activities used $6,459,000 in 2004, compared to generating $7,958,000
in 2003. The Company used proceeds from new note agreements originated in 2004
and 2003 to refinance existing debt with higher interest rates and to fund the
acquisition of new software systems and other capital expenditures. Primary uses
of cash in both 2004 and 2003 consisted of payments for long-term debt and
capital lease obligations. In 2003, the Company issued 1.2 million shares of
common stock at $8 per share in a private placement transaction. Net proceeds,
after syndication and other costs, were $8,855,000 and were used primarily to
fund current operations.
Senior Revolving Credit Facility
In October 2002, the Company entered into a $35 million senior revolving credit
facility with certain lenders to finance a portion of the purchase price and
related closing costs for the RMH acquisition and to provide working capital and
letter of credit availability for future activities of the Company. Borrowings
under the credit facility are secured by substantially all of the Company's
non-aircraft assets, including accounts receivable, inventory,
19
equipment and general intangibles. The facility matures October 16, 2006 but can
be prepaid at any time, subject to payment of an early termination fee ranging
from .25% to 1% if the termination occurs prior to October 16, 2005.
Indebtedness under the credit facility bears 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 to 0.75% or
(ii) a rate equal to LIBOR plus an applicable margin ranging from 1.75% to
3.00%. As of December 31, 2004, the weighted average interest rate on the
outstanding balance against the line was 4.72%. The amount of borrowings
permitted under the credit facility is based on a borrowing base comprised of
(i) 75% of accounts receivable from Medicare, Medicaid, insurance companies and
community-based payers and 85% of other accounts receivable, and (ii) the lesser
of (A) 60% of inventory valued at the lower of cost or market, (B) 85% of
inventory valued at liquidation value, or (C) $15 million. At December 31, 2004,
$35,000,000 was available under the credit facility, and $14,719,000 was drawn
against the line.
Payment obligations under the credit facility accelerate upon the occurrence of
defined events of default, including the following: failure to pay principal or
interest or to perform covenants under the credit facility or other
indebtedness; events of insolvency or bankruptcy; failure to timely discharge
judgments of $250,000 or more; failure to maintain the first priority status of
liens under the credit facility; levy against a material portion of the
Company's assets; default under other indebtedness; suspension of material
governmental permits; interruption of operations at any Company facility that
has a material adverse effect; and a change of control in the Company.
The credit facility contains various covenants that limit, among other things,
the Company's ability to create liens, declare dividends, make loans and
investments, enter into real property leases exceeding specified expenditure
levels, make any material change to the nature of the Company's business, enter
into any transaction with affiliates other than on arms' length terms, prepay
indebtedness, enter into a merger or consolidation, or sell assets. The credit
facility also places limits on the amount of new indebtedness, operating lease
obligations, and unfinanced capital expenditures which the Company can incur in
a fiscal year. The Company is required to maintain certain financial ratios as
defined in the credit facility. As of December 31, 2004, the Company was in
compliance with the covenants of the credit facility.
Subordinated Debt
On October 16, 2002, the Company issued $23 million in subordinated notes to
Prudential Capital Partners, L.P. and Prudential Capital Partners Management
Fund, L.P. (together, the Subordinated Lenders) to finance the acquisition of
RMH. The notes are unsecured and provide for quarterly payment of interest only
at 12% per annum, with all principal due October 16, 2007. With certain
exceptions as defined in the notes, the notes may not be prepaid until January
1, 2005, and prepayments after January 1, 2005, will be at a declining premium.
The securities purchase agreement entered into in connection with the notes
contains various covenants that limit, among other things, the Company's ability
to create liens, declare dividends, make certain loans, enter into real property
leases exceeding specified expenditure levels, make any material change to the
nature of the Company's business, enter into any transaction with affiliates
other than on arms' length terms, prepay indebtedness, enter into a merger or
consolidation, sell or discount receivables, or sell assets. The purchase
agreement also places limits on the amount of new indebtedness, operating lease
obligations, and unfinanced capital expenditures which the Company can incur in
a fiscal year. The Company is required to maintain certain financial ratios as
defined in the purchase agreement. As of December 31, 2004, the Company was in
compliance with the covenants.
Payment obligations under the subordinated notes accelerate upon the occurrence
of defined events of default, including the following: failure to pay principal
or interest or to perform covenants under the notes and related purchase
agreement or other indebtedness; events of insolvency or bankruptcy; failure to
timely discharge judgments of $500,000 or more; failure to file and keep
effective a registration statement relating to the warrants issued to the
Subordinated Lenders; and a change of control in the Company.
Under an amendment to the agreement, the Company accrued an amendment fee of
$500,000 in 2004 in exchange for the elimination of a financial covenant for the
duration of the agreement. The fee is expected to be paid in the first quarter
of 2005.
20
Other Notes
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 December 2004 the Company originated a note payable of $1,953,000 with
interest at 5.36% to refinance the balloon payment due under a capital lease
obligation. The note is payable through December 2010.
New Community-based Operations
Opening a new community-based operation typically requires an investment in an
additional aircraft, aviation and medical personnel, and crew quarters. The
Company may take possession of the additional aircraft up to three months prior
to the commencement of operations in order to retrofit the aircraft for medical
transport. Staff may also be hired a month in advance of the operation start
date. Because of the delay between date of transport and collection of
receivables from the patients or their insurers, new community-based operations
may not produce positive cash flow during at least the first three months of
operation.
Other Sources
As of December 31, 2004, the Company held unencumbered aircraft with a net book
value of $9.0 million and has additional equity in other encumbered aircraft
which could be utilized as collateral for borrowing funds as an additional
source of working capital if necessary. The Company also has $19,073,000 unused
capacity on its senior revolving credit facility. The Company believes that
these borrowing resources, coupled with favorable results of operations, will
allow the Company to meet its obligations in the coming year.
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
The Company opened CBM operations at a new location in Kentucky during the
fourth quarter of 2004. In the first quarter of 2005, the Company purchased the
operations of a hospital-based program in northern California and expanded it
from one base to two. 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 the fourth quarter of 2004, the Company expanded two existing contracts in
Colorado and North Carolina to additional satellite bases. The Company expects
similar expansions to satellite locations under four 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.
Products Division
As of December 31, 2004, the Company was continuing the production of 13 HH-60L
units and 19 MEV 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. Remaining revenue for all contracts in process as of
December 31, 2004, is estimated at $2.1 million.
21
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 119 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 last six months of 2004 the Company implemented new finance and
accounting and new dispatch 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.
During the first quarter of 2005, the Company reached an agreement to amend to
its senior revolving credit facility. The amendment extends the maturity of the
revolving credit facility to April 2010 and includes a $20 million term loan,
the proceeds of which will be used to retire the Company's 12% subordinated
debt. The terms and conditions of the senior revolving credit facility remain
relatively unchanged under the amendment. The term loan will be payable through
April 2010 and will 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 2.75% to 3.75%. Payments
will consist of interest only during the first year with the principal payable
as follows: $6 million in each of years 2 and 3, $2 million in each of years 4
and 5, and $4 million at maturity. The Company expects to write off
approximately $2.0 million in debt origination costs and note discount related
to the subordinated debt and to pay a prepayment penalty of approximately $1.4
million. While there are certain conditions that must be met in order to
finalize the amendment, the Company expects to meet those conditions either late
in the first quarter or early in the second quarter of 2005. Closing costs
associated with the amendment are estimated to be $300,000.
There can be no assurance that the Company will continue to maintain flight
volume or current collection rates on receivables for CBM operations, renew
operating agreements for its HBM operations, or generate new profitable
contracts for the Products Division.
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.
22
- Highly leveraged balance sheet - The Company is obligated under
debt facilities providing for up to approximately $104.8 million of
indebtedness, of which approximately $84.5 million was outstanding at
December 31, 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 to obtain such waivers, the Company will not
be required to pay lenders significant cash or equity compensation.
- Employee unionization - In September 2003, the Company's pilots
voted to be represented by a collective bargaining unit, 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 under investigation by the National Transportation
Safety Board. The outcome of these investigations and the potential
impact on the Company's operations cannot yet be ascertained.
- Compliance with corporate governance and public disclosure
regulations - New laws, regulations, and standards relating to
corporate governance and public disclosure-including the
Sarbanes-Oxley Act of 2002, new SEC regulations, and NASDAQ National
Market rules-are subject to varying interpretations in many cases due
to lack of specificity. Their application may evolve over time as new
guidance is provided by regulatory and governing bodies, which may
result in continuing uncertainty regarding compliance matters and
higher costs necessitated by ongoing revisions to disclosure and
governance practices. The Company's efforts to maintain high standards
of corporate governance and public disclosure in compliance with
evolving laws and regulations have resulted in, and are likely to
continue to result in, increased general and administrative expenses
and a diversion of management's time and attention from
revenue-generating activities to compliance activities. In particular,
compliance with Section 404 of the Sarbanes-Oxley Act of 2002, which
requires the Company to include management and auditor reports on
internal controls as part of its annual report, has required
commitment of significant financial and managerial resources. In
addition, board members, the chief executive officer, and chief
financial officer could face an increased risk of personal liability
in connection with the performance of their duties. As a result, the
Company may have difficulty attracting and retaining qualified
23
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 2.2% of total operating expenses
for the year ended December 31, 2004. 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.
- 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 publicity and interruption of air medical services to client
hospitals, which could adversely affect the Company's operating
results and relationship with such hospitals.
24
- 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
December 31, 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.
- Dependence on third party suppliers - The Company currently
obtains a substantial portion of its helicopter spare parts and
components from Bell and 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.
25
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 (i.e., Medicare and Medicaid). Estimates of
contractual allowances are initially determined based on historical discount
percentages for Medicare and Medicaid patients and adjusted periodically based
on actual discounts. If actual discounts realized are more or less than those
projected by management, adjustments to contractual allowances may be required.
Based on related flight revenue for the year ended December 31, 2004, a change
of 1% in the percentage of estimated contractual discounts would have resulted
in a change of approximately $2,599,000 in flight revenue.
Revenue related to fixed fee medical interior and products contracts is recorded
as costs are incurred using the percentage of completion method of accounting.
The Company estimates the percentage of completion based on costs incurred to
date as a percentage of an estimate of the total costs to complete the project.
Losses on contracts in process are recognized when determined. If total costs to
complete a project are greater or less than estimated, the gross margin on the
project may be greater or less than originally recorded under the percentage of
completion method.
Uncollectible Receivables
The Company responds to calls for air medical transports without pre-screening
the credit worthiness of the patient. Uncollectible trade receivables are
charged to operations using the allowance method. Estimates of uncollectible
receivables are determined monthly based on historical collection rates and
adjusted monthly thereafter based on actual collections. If actual future
collections are more or less than those projected by management, adjustments to
allowances for uncollectible accounts may be required. There can be no guarantee
that the Company will continue to experience the same collection rates that it
has in the past. Based on related net flight revenue for the year ended December
31, 2004, a change of 1% in the percentage of estimated uncollectible accounts
would have resulted in a change of approximately $1,777,000 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, 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.
26
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