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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 

 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended­­­­­ 
September 30, 2012

OR

o
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
 
AIR METHODS CORPORATION
(Exact name of Registrant as Specified in Its Charter)

Delaware
 
84-0915893
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification Number)
     
7301 South Peoria, Englewood, Colorado
 
80112
(Address of Principal Executive Offices)
 
(Zip Code)
 
Registrant’s Telephone Number, Including Area Code (303) 792-7400

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  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated Filer x
 
Accelerated Filer o
Non-accelerated Filer o (Do not check if a smaller reporting company)
 
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) Yes o  No  x

The number of shares of Common Stock, par value $.06, outstanding as of November 5, 2012, was 12,907,154.
 


 
 

 

TABLE OF CONTENTS
 
PART I.
FINANCIAL INFORMATION
 
       
 
Item 1.
 
       
   
1
       
   
3
       
   
4
       
   
6
       
 
Item 2.
13
       
 
Item 3.
21
       
 
Item 4.
21
       
PART II.  
OTHER INFORMATION
 
       
 
Item 1.
22
       
 
Item 1A.  
22
       
 
Item 2.
22
       
 
Item 3.
22
       
 
Item 4.
22
       
 
Item 5.
23
       
 
Item 6.
23
       
24
 
 
PART I: FINANCIAL INFORMATION
 
Item 1. Consolidated Financial Statements
 
Air Methods Corporation and Subsidiaries
 
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share amounts)
(unaudited)

   
September 30,
2012
   
December 31,
2011
 
Assets
           
             
Current assets:
           
Cash and cash equivalents
  $ 3,807       3,562  
Current installments of notes receivable
    898       687  
Receivables:
               
Trade, net (note 4)
    235,764       187,056  
Refundable income taxes
    --       1,808  
Other
    2,409       1,924  
Total receivables
    238,173       190,788  
                 
Inventories
    37,481       33,089  
Work-in-process on medical interiors and products contracts
    2,905       1,369  
Assets held for sale
    12,349       2,807  
Costs and estimated earnings in excess of billings on uncompleted contracts
     3,242        1,854  
Refundable deposits
    13,251       14,146  
Prepaid expenses and other (note 6)
    7,325       7,417  
                 
Total current assets
    319,431       255,719  
                 
Property and equipment:
               
Land
    251       251  
Flight and ground support equipment
    351,277       343,069  
Aircraft under capital leases
    363,122       408,985  
Aircraft rotable spare parts
    52,993       44,020  
Furniture and office equipment
    43,041       41,824  
      810,684       838,149  
Less accumulated depreciation and amortization
    (258,740 )     (268,571 )
                 
Net property and equipment
    551,944       569,578  
                 
Goodwill (note 2)
    114,857       115,117  
Notes and other receivables, less current installments
    114       117  
Intangible assets, net of accumulated amortization of $6,784 and $4,374 at September 30, 2012 and December 31, 2011, respectively
     62,136        64,752  
Other assets
    20,313       23,188  
                 
Total assets
  $ 1,068,795       1,028,471  

(Continued)
 
 
Air Methods Corporation and Subsidiaries

CONSOLIDATED BALANCE SHEETS, Continued
(Amounts in thousands, except share and per share amounts)
(unaudited)
 
   
September 30,
2012
   
December 31,
2011
 
Liabilities and Stockholders' Equity
           
             
Current liabilities:
           
Notes payable
  $ 4,640       27,940  
Current installments of long-term debt
    20,261       18,889  
Current installments of obligations under capital leases
    42,332       49,100  
Accounts payable
    20,782       15,890  
Deferred revenue
    3,148       4,493  
Billings in excess of costs and estimated earnings on uncompleted contracts
     1,155        2,726  
Accrued wages and compensated absences
    14,409       20,267  
Current income taxes payable
    7,244       --  
Due to third party payers
    6,303       5,604  
Deferred income taxes
    9,030       7,654  
Other accrued liabilities
    15,797       18,145  
                 
Total current liabilities
    145,101       170,708  
                 
Long-term debt, less current installments
    248,379       243,678  
Obligations under capital leases, less current installments
    214,579       240,208  
Deferred income taxes
    61,704       49,966  
Other liabilities
    31,253       36,009  
                 
Total liabilities
    701,016       740,569  
                 
Stockholders' equity (note 3):
               
Preferred stock, $1 par value.  Authorized 5,000,000 shares, none issued
     --        --  
Common stock, $.06 par value. Authorized 23,500,000 shares; issued 12,963,868 and 12,799,560 shares at September 30, 2012 and December 31, 2011, respectively; outstanding 12,906,155 and 12,739,560 shares at September 30, 2012 and December 31, 2011, respectively
     773        764  
Additional paid-in capital
    104,097       95,960  
Retained earnings
    262,909       191,178  
                 
Total stockholders' equity
    367,779       287,902  
                 
Total liabilities and stockholders’ equity
  $ 1,068,795       1,028,471  

See accompanying notes to unaudited consolidated financial statements.
 
 
Air Methods Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except share and per share amounts)
(unaudited)
 
   
Three Months Ended
September 30,
   
Nine Months Ended
 September 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Revenue:
                       
Patient transport revenue, net of provision for contractual discounts (note 4)
  $  248,384        189,851        695,963        437,147  
Provision for uncompensated care (note 4)
    (95,289 )     (70,519 )     (258,098 )     (150,650 )
Patient transport revenue, net
    153,095       119,332       437,865       286,497  
Air medical services contract revenue
    58,014       55,381       168,854       153,629  
Sales of medical interiors and products
    8,490       8,702       23,238       22,044  
Other
    1,691       1,757       4,627       5,069  
      221,290       185,172       634,584       467,239  
Operating expenses:
                               
Flight centers
    81,251       70,479       238,786       182,456  
Aircraft operations
    37,839       30,871       110,946       88,892  
Cost of medical interiors and products sold
    5,871       6,058       16,186       15,452  
Depreciation and amortization
    20,638       19,030       62,460       52,217  
Loss (gain) on disposition of assets, net
    985       (264 )     774       (290 )
General and administrative
    23,478       23,331       73,902       60,338  
      170,062       149,505       503,054       399,065  
                                 
Operating income
    51,228       35,667       131,530       68,174  
                                 
Other income (expense):
                               
Interest expense
    (5,022 )     (5,383 )     (15,887 )     (14,204 )
Other, net
    711       872       2,639       2,985  
                                 
Income before income taxes
    46,917       31,156       118,282       56,955  
                                 
Income tax expense
    (19,073 )     (12,616 )     (46,551 )     (22,783 )
                                 
Net income
  $ 27,844       18,540       71,731       34,172  
                                 
Basic income per common share (note 5)
  $ 2.16       1.46       5.58       2.70  
                                 
Diluted income per common share (note 5)
  $ 2.14       1.44       5.52       2.67  
                                 
Weighted average number of common shares outstanding – basic
    12,896,812       12,688,791        12,850,529        12,651,949  
                                 
Weighted average number of common shares outstanding – diluted
    13,016,749        12,837,530        12,989,979        12,806,716  

See accompanying notes to unaudited consolidated financial statements.
 
 
Air Methods Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(unaudited)

   
Nine Months Ended September 30,
 
   
2012
   
2011
 
             
Cash flows from operating activities:
           
Net income
  $ 71,731       34,172  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization expense
    62,460       52,217  
Deferred income tax expense
    12,888       9,076  
Stock-based compensation
    1,532       2,022  
Excess tax benefit from exercise of stock options
    (2,288 )     (725 )
Loss (gain) on disposition of assets, net
    774       (290 )
Unrealized loss on derivative instrument
    239       305  
Changes in assets and liabilities, net of effects of acquisitions:
               
Decrease (increase) in prepaid expenses and other current assets
    717       (13,922 )
Increase in receivables
    (47,385 )     (14,379 )
Increase in inventories
    (5,928 )     (5,256 )
Increase in costs in excess of billings
    (1,388 )     (1,001 )
Increase (decrease) in accounts payable, other accrued liabilities, and other liabilities
     5,895       (6,381 )
Decrease in deferred revenue and billings in excess of costs
    (2,916 )     (1,534 )
Net cash provided by operating activities
    96,331       54,304  
                 
Cash flows from investing activities:
               
Acquisition of OF Air Holdings Corporation (note 2)
    (3,176 )     (201,728 )
Acquisition of membership interest of United Rotorcraft Solutions, LLC
    --       (1,554 )
Buy-out of previously leased aircraft
    (52,329 )     (17,429 )
Acquisition of property and equipment
    (8,138 )     (16,288 )
Proceeds from disposition and sale of equipment and assets held for sale
    30,673       7,595  
Decrease in notes receivable and other assets
    1,517       40  
Net cash used in investing activities
    (31,453 )     (229,364 )
 
(Continued)
 

Air Methods Corporation and Subsidiaries

CONSOLIDATED STATEMENTS OF CASH FLOWS, Continued
(Amounts in thousands)
(unaudited)

   
Nine Months Ended September 30,
 
   
2012
   
2011
 
             
Cash flows from financing activities:
           
Proceeds from issuance of common stock
  $ 4,326       2,859  
Excess tax benefit from exercise of stock options
    2,288       725  
Borrowings under line of credit
    73,738       --  
Payments under line of credit
    (55,008 )     --  
Proceeds from issuance of long-term debt
    --       200,000  
Payments for financing costs
    (114 )     (1,788 )
Payments of long-term debt and notes payable
    (12,657 )     (40,626 )
Payments of capital lease obligations
    (77,206 )     (44,305 )
Net cash provided by (used in) financing activities
    (64,633 )     116,865  
                 
Increase (decrease) in cash and cash equivalents
    245       (58,195 )
                 
Cash and cash equivalents at beginning of period
    3,562       60,710  
                 
Cash and cash equivalents at end of period
  $ 3,807       2,515  
                 
Interest paid in cash during the period
  $ 15,531       13,321  
Income taxes paid in cash during the period
  $  22,141        5,091  

Non-cash investing and financing activities:
 
In the nine months ended September 30, 2012, the Company entered into notes payable of $4,640 to finance the purchase of aircraft which were held in property and equipment pending permanent lease financing as of September 30, 2012, and into capital leases of $44,809 to finance the purchase of aircraft. The Company also settled notes payable of $27,940 in exchange for the aircraft securing the debt.
 
In the nine months ended September 30, 2011, the Company entered into notes payable of $20,353 to finance the purchase of aircraft which were held in property and equipment pending permanent lease financing as of September 30, 2011, and entered into capital leases of $18,966 to finance the purchase of aircraft and other equipment.

See accompanying notes to unaudited consolidated financial statements.
 
 
Air Methods Corporation and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(unaudited)

(1)
Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and instructions to Form 10-Q and Regulation S-X. Accordingly, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the condensed consolidated financial statements for the respective periods. Interim results are not necessarily indicative of results for a full year. The condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 2011.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The Company considers its critical accounting policies involving more significant judgments and estimates to be those related to revenue recognition, deferred income taxes, valuation of long-lived assets, and fair values of assets acquired and liabilities assumed in business combinations. Actual results could differ from those estimates.

(2)
Acquisition of OF Airholdings Corporation
 
On August 1, 2011, the Company acquired 100% of the outstanding common stock of OF Air Holdings Corporation and its subsidiaries, including Omniflight Helicopters, Inc. (together, Omniflight), for a cash purchase price of $201.9 million, subject to final determination of working capital, as defined in the merger agreement, as of the closing date. As of December 31, 2011, the Company had recorded a liability of $3,119,000 for the estimated increase to the purchase price for the change in working capital. Based upon final agreed upon adjustments to the working capital measurement, the Company paid the sellers $3,176,000 during the first quarter of 2012, and no further amounts are due the sellers. The purchase price was financed primarily through a term loan under the Company’s Amended and Restated Revolving Credit, Term Loan and Security Agreement.
 
 
Air Methods Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements, continued
(unaudited)

(2)
Acquisition of OF Airholdings Corporation, continued

The allocation of the purchase price was as follows (amounts in thousands):

   
Allocation at
December 31, 2011
   
Adjustments
   
Revised Allocation
 
Assets purchased:
                 
Receivables
  $ 28,622       --       28,622  
Aircraft
    33,500       --       33,500  
Goodwill
    89,116       (260 )     88,856  
Amortizable intangible assets
    63,100       --       63,100  
Aircraft under capital leases
    29,405       --       29,405  
Equipment and other property
    5,986       --       5,986  
Spare parts inventories
    4,525       --       4,525  
Other
    14,521       (42 )     14,479  
Total assets
    268,775       (302 )     268,473  
                         
Capital lease obligations assumed
    (38,034 )     --       (38,034 )
Net deferred tax liabilities
    (5,961 )     (225 )     (6,186 )
Other liabilities assumed
    (19,765 )     584       (19,181 )
Total liabilities assumed
    (63,760 )     359       (63,401 )
Purchase price
  $ 205,015       57       205,072  

Adjustments to the purchase price allocation during 2012 included the working capital adjustment to the purchase price, as described above, and revised estimates of liabilities related to aircraft repair costs based upon verification of open repair orders with aircraft parts vendors. The Company does not expect further adjustments to the purchase price allocation.

(3)
Stockholders’ Equity

Changes in stockholders’ equity for the nine months ended September 30, 2012, consisted of the following (amounts in thousands except share amounts):
 
   
Shares
       
   
Outstanding
   
Amount
 
             
Balances at January 1, 2012
    12,739,560     $ 287,902  
                 
Issuance of common shares for options exercised
    137,590       4,326  
Stock-based compensation
    29,005       1,532  
Tax benefit from exercise of stock options
    --       2,288  
Net income
    --       71,731  
                 
Balances at September 30, 2012
    12,906,155     $ 367,779  

 
Air Methods Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements, continued
(unaudited)

(4)
Revenue Recognition

In the first quarter of 2012, the Company adopted ASU No. 2011-07, Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for Certain Health Care Entities. Trade receivables are presented net of allowances for contractual discounts and uncompensated care. The Company determines its allowances for contractual discounts and uncompensated care based on estimated payer mix, payer reimbursement schedules, and historical collection experience. The allowances are reviewed monthly and adjusted periodically based on actual collections. Billings are charged off against the uncompensated care allowance when it is probable that the receivable will not be recovered. The allowance for contractual discounts is related primarily to Medicare and Medicaid patients. The allowance for uncompensated care is related primarily to receivables recorded for self-pay patients.

The Company has not changed its discount policies related to self-pay patients or deductible and copayment balances for insured patients during either 2012 or 2011. The allowance for uncompensated care was 42.9% of receivables from non-governmental payers as of September 30, 2012, compared to 38.8% at December 31, 2011, and 40.0% at September 30, 2011. The increase at September 30, 2012, compared to December 31 and September 30, 2011, is due primarily to the impact of the acquisition of Omniflight in August 2011 and to regularly scheduled price increases. Omniflight had a higher gross charge structure and, therefore, a higher percentage of uncollectible accounts, than the Company’s historical operations prior to the acquisition.

The Company recognizes patient transport revenue at its standard rates for services provided, regardless of expected payer. In the period that services are provided and based upon historical experience, the Company records a significant provision for uncompensated care related to uninsured patients who will be unable or unwilling to pay for the services provided. Air medical services contract revenue consists of monthly fees and hourly flight fees billed to hospitals or other institutions under exclusive operating agreements. These fees are earned regardless of when, or if, the institution is reimbursed for these services by its patients, their insurers, or the federal government. As a result, the Company does not maintain an allowance or provision for uncompensated care for air medical services contract revenue and related receivables. Patient transport revenue, net of provision for contractual discounts but before provision for uncompensated care, by major payer class, was as follows (amounts in thousands):

   
For quarter ended
September 30,
   
For nine months ended
September 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Third-party payers
  $ 166,293       146,463       525,059       339,701  
Self-pay
    82,091       43,388       170,904       97,446  
Total
  $ 248,384       189,851       695,963       437,147  

The provision for uncompensated care was 97.9% of revenue attributed to self-pay patients and 21.5% of revenue attributed to all other non-governmental payers for the nine months ended September 30, 2012, compared to 98.1% of revenue attributed to self-pay patients and 20.1% of revenue attributed to all other non-governmental payers for the nine months ended September 30, 2011.
 

Air Methods Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements, continued
(unaudited)

(5)
Income per Share

Basic earnings per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing net income by all common shares outstanding during the period and dilutive potential common shares.

The reconciliation of basic to diluted weighted average common shares outstanding is as follows:

   
2012
   
2011
 
For quarter ended September 30:
           
Weighted average number of common shares outstanding – basic
    12,896,812       12,688,791  
Dilutive effect of:
               
Common stock options
    102,653       135,078  
Unvested restricted stock
    17,284       13,661  
Weighted average number of common shares outstanding – diluted
    13,016,749       12,837,530  
                 
For nine months ended September 30:
               
Weighted average number of common shares outstanding – basic
    12,850,529       12,651,949  
Dilutive effect of:
               
Common stock options
    125,476       148,304  
Unvested restricted stock
    13,974       6,463  
Weighted average number of common shares outstanding – diluted
    12,989,979       12,806,716  

 (6)
Fair Value of Financial Instruments

ASC Topic 820, “Fair Value Measurements and Disclosures,” requires disclosures about how fair value is determined for assets and liabilities and establishes a hierarchy by which these assets and liabilities must be grouped based on the type of inputs used in measuring fair value as follows:

 
Level 1:
quoted prices in active markets for identical assets or liabilities;
 
Level 2:
quoted prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability; or
 
Level 3:
unobservable inputs, such as discounted cash flow models or valuations.

In the first quarter of 2012, the Company adopted Accounting Standards Update (ASU) No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The following methods and assumptions were used to estimate the fair value of each class of financial instruments:
 
Cash and cash equivalents, accounts receivable, notes receivable, notes payable, accounts payable, and accrued liabilities:
 
The carrying amounts approximate fair value because of the short maturity of these instruments.
 
 
Air Methods Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements, continued
(unaudited)

(6)
Fair Value of Financial Instruments, continued

Derivative instruments:

The Company endeavors to acquire jet fuel at the lowest possible cost and to reduce volatility in operating expenses through the use of short-term purchased call options. Financial derivative instruments covering fuel purchases are included in prepaid expenses and other current assets at fair value. Fair value is determined based on quoted prices in active markets for similar instruments and is classified as Level 2 in the fair value hierarchy. The fair value of all fuel derivative instruments included in prepaid expenses and other current assets was $18,000 at September 30, 2012, and $256,000 at December 31, 2011. The Company’s financial derivatives do not qualify for hedge accounting, and, therefore, realized and non-cash mark to market adjustments are included in aircraft operations expense in the Company’s statement of income. Aircraft operations expense included a non-cash mark to market derivative gain of $3,000 and a loss of $239,000 for the quarter and nine months ended September 30, 2012, respectively, compared to losses of $528,000 and $305,000 for the quarter and nine months ended September 30, 2011. There were no cash settlements under the terms of the agreement in the quarter and nine months ended September 30, 2012, compared to $307,000 and $884,000 in the quarter and nine months ended September 30, 2011, respectively.
 
Long-term debt:
 
The fair value of long-term debt is classified as Level 3 in the fair value hierarchy because it is determined based on the present value of future contractual cash flows discounted at an interest rate that reflects the risks inherent in those cash flows. Based on the borrowing rates currently available to the Company for loans with similar terms and average maturities and on recent transactions, the fair value of long-term debt as of September 30, 2012, is estimated to be $272,276,000, compared to a carrying value of $268,640,000. The fair value of long-term debt as of December 31, 2011, was estimated to be $266,213,000, compared to a carrying value of $262,567,000.

(7)
New Accounting Pronouncements

In July 2012, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment, which allows an entity to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that an indefinite-lived intangible asset is impaired. If, after this assessment, an entity concludes that it is not more likely than not that an indefinite-lived intangible asset is impaired, the entity is not required to take further action. If an entity concludes otherwise, it is required to determine whether impairment exists by comparing the fair value with the carrying amount of the asset. The ASU is effective for periods beginning after September 15, 2012. The Company does not expect the implementation of ASU No. 2012-02 to have a material effect on its financial position or results of operations.
 

Air Methods Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements, continued
(unaudited)

 (8)
Business Segment Information

Summarized financial information for the Company’s operating segments is shown in the following table (amounts in thousands). Amounts in the “Corporate Activities” column represent corporate headquarters expenses, corporate income tax expense, and results of insignificant operations. Effective September 1, 2012, the Company combined two of its operating segments,  Community-Based Services (CBS) and Hospital-Based Services (HBS), into a single operating segment reporting to the President of Air Medical Services. The decision to combine CBS and HBS delivery models for air medical transportation services was made in order to improve efficiency and communication between regional management. In addition, with increasing conversion of HBS contracts into CBS operations and the development of alternative delivery models in partnering with hospitals to provide air medical transportation services, the lines between the two delivery models have begun to blur. CBS and HBS segment results for prior periods have been combined in the following table to reflect the new segment definition. The Company does not allocate assets between operating segments for internal reporting and performance evaluation purposes. Operating segments and their principal products or services are as follows:

 
Air Medical Services (AMS) - provides air medical transportation services to the general population as an independent service and to hospitals or other institutions under exclusive operating agreements. Services include aircraft operation and maintenance, medical care, dispatch and communications, and medical billing and collection.
 
United Rotorcraft (UR) Division - designs, manufactures, and installs aircraft medical interiors and other aerospace and medical transport products for domestic and international customers.
 

Air Methods Corporation and Subsidiaries
Notes to Unaudited Consolidated Financial Statements, continued
(unaudited)

(8)
Business Segment Information, continued

 
For quarter ended September 30:
 
AMS
   
UR
   
Corporate
Activities
   
Intersegment
Eliminations
   
Consolidated
 
2012
                             
External revenue
  $ 212,802       8,358       130       --       221,290  
Intersegment revenue
    --       2,480       --       (2,480 )     --  
Total revenue
    212,802       10,838       130       (2,480 )     221,290  
                                         
Operating expenses, excluding depreciation & amortization
    (135,968 )     (8,361 )     (7,251 )      2,156       (149,424 )
Depreciation & amortization
    (19,905 )     (371 )     (362 )     --       (20,638 )
Interest expense
    (4,912 )     --       (110 )     --       (5,022 )
Other income, net
    686       --       25       --       711  
Income tax expense
    --       --       (19,073 )     --       (19,073 )
Segment net income (loss)
  $ 52,703       2,106       (26,641 )     (324 )     27,844  
                                         
2011
                                       
External revenue
  $ 176,483       8,687       2       --       185,172  
Intersegment revenue
    20       7,946       --       (7,966 )     --  
Total revenue
    176,503       16,633       2       (7,966 )     185,172  
                                         
Operating expenses, excluding depreciation & amortization
    (116,291 )     (11,979 )     (7,858 )      5,653       (130,475 )
Depreciation & amortization
    (18,413 )     (335 )     (282 )     --       (19,030 )
Interest expense
    (5,124 )     (4 )     (255 )     --       (5,383 )
Other income, net
    838       --       34       --       872  
Income tax expense
    --       --       (12,616 )     --       (12,616 )
Segment net income (loss)
  $ 37,513       4,315       (20,975 )     (2,313 )     18,540  

For nine months ended September 30:
                             
2012
                             
External revenue
  $ 611,379       23,029       176       --       634,584  
Intersegment revenue
    --       16,025       --       (16,025 )     --  
Total revenue
    611,379       39,054       176       (16,025 )     634,584  
                                         
Operating expenses, excluding depreciation & amortization
    (400,145 )     (29,420 )     (23,764 )      12,735       (440,594 )
Depreciation & amortization
    (60,407 )     (1,038 )     (1,015 )     --       (62,460 )
Interest expense
    (15,462 )     (1 )     (424 )     --       (15,887 )
Other income, net
    2,544       --       95       --       2,639  
Income tax expense
    --       --       (46,551 )     --       (46,551 )
Segment net income (loss)
  $ 137,909       8,595       (71,483 )     (3,290 )     71,731  
                                         
2011
                                       
External revenue
  $ 445,231       21,986       22       --       467,239  
Intersegment revenue
    135       17,470       --       (17,605 )     --  
Total revenue
    445,366       39,456       22       (17,605 )     467,239  
                                         
Operating expenses, excluding depreciation & amortization
    (310,894 )     (29,272 )     (19,687 )      13,005       (346,848 )
Depreciation & amortization
    (50,481 )     (913 )     (823 )     --       (52,217 )
Interest expense
    (13,626 )     (13 )     (565 )     --       (14,204 )
Other income, net
    2,722       --       263       --       2,985  
Income tax expense
    --       --       (22,783 )     --       (22,783 )
Segment net income (loss)
  $ 73,087       9,258       (43,573 )     (4,600 )     34,172  

 
 
ITEM 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of the results of operations and financial condition should be read in conjunction with our consolidated financial statements and notes thereto included in Item 1 of this report. This report, including the information incorporated by reference, contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The use of any of the words “believe,” “expect,” “anticipate,” “plan,” “estimate,” and similar expressions are intended to identify such statements. Forward-looking statements include statements concerning our possible or assumed future results; flight volume and collection rates for patient transports; size, structure and growth of our air medical services and products markets; continuation and/or renewal of hospital contracts; acquisition of new and profitable United Rotorcraft Division contracts; impact of the Patient Protection and Affordable Care Act and other changes in laws and regulations; and other matters. The actual results that we achieve may differ materially from those discussed in such forward-looking statements due to the risks and uncertainties described in the Risk Factors section of this report, in Management’s Discussion and Analysis of Financial Condition and Results of Operations sections of this report, and in other sections of this report, as well as in our annual report on Form 10-K. We undertake no obligation to update any forward-looking statements.

Overview

We provide air medical transportation services throughout the United States and design, manufacture, and install medical aircraft interiors and other aerospace products for domestic and international customers. Our divisions, or business segments, are organized according to the type of service or product provided and consist of the following:
Air Medical Services (AMS) - provides air medical transportation services to the general population as an independent service (also called community-based services) and to hospitals or other institutions under exclusive operating agreements (also called hospital-based services). Patient transport 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. Air medical services contract revenue consists of fixed monthly fees (approximately 80% of total contract revenue) and hourly flight fees (approximately 20% of total contract revenue) billed to hospitals or other institutions. In the nine months ended September 30, 2012, the AMS Division generated 96% of our total revenue, compared to 95%  in 2011.
United Rotorcraft (UR) Division - designs, manufactures, and installs aircraft medical interiors and other aerospace and medical transport products for domestic and international customers. The UR Division generated 4% of our total revenue in the nine months ended September 30, 2012, compared to 5% in 2011.

See Note 8 to the consolidated financial statements included in Item 1 of this report for operating results by segment.

We believe that the following factors have the greatest impact on our results of operations and financial condition:

Flight volume. Almost all of patient transport revenue is derived from flight fees, as compared to approximately 20% of air medical services contract revenue. By contrast, 80% of our costs primarily associated with flight operations (including salaries, aircraft ownership costs, hull insurance, and general and administrative expenses) incurred during the first nine months of 2012 were mainly fixed in nature. While flight volume is affected by many factors, including competition and the effectiveness of marketing and business development initiatives, the greatest single variable in quarterly comparatives has historically been weather conditions. Adverse weather conditions—such as fog, high winds, or heavy precipitation—hamper our ability to operate our aircraft safely and, therefore, result in reduced flight volume. Total patient transports for community-based locations were approximately 14,800 and 42,600 for the quarter and nine months ended September 30, 2012, respectively, compared to approximately 13,200 and 32,400 for the quarter and nine months ended September 30, 2011, respectively. Patient transports for community-based locations open longer than one year (Same-Base Transports) were approximately 13,000 and 31,900 in the quarter and nine months ended September 30, 2012, respectively, compared to approximately 12,700 and 31,500 in the quarter and nine months ended September 30, 2011, respectively. Cancellations due to unfavorable weather conditions for community-based locations open longer than one year were 172 and 2,177 lower in the quarter and nine months ended September 30, 2012, compared to 2011. Requests for community-based services increased by 2.4% and decreased by 2.3% for the quarter and nine months ended September 30, 2012, respectively, for bases open greater than one year.
 

 
Reimbursement per transport. We respond to calls for air medical transports without pre-screening the creditworthiness of the patient and are subject to collection risk for services provided to insured and uninsured patients. Medicare and Medicaid also receive contractual discounts from our standard charges for flight services. Patient transport revenue is recorded net of provisions for contractual discounts and estimated uncompensated care. Both provisions are estimated during the period the related services are performed based on historical collection experience and any known trends or changes in reimbursement rate schedules and payer mix. The provisions are adjusted as required based on actual collections in subsequent periods. Net reimbursement per patient transport is primarily a function of price, payer mix, and timely and effective collection efforts. 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. In addition, the collection rate is impacted by changes in the cost of healthcare and health insurance; as the cost of healthcare increases, health insurance coverage provided by employers may be reduced or eliminated entirely, resulting in an increase in the uninsured population. Most of the significant provisions of the Patient Protection and Affordable Care Act are not scheduled to take effect until 2014, and the impact on our reimbursement rates is, therefore, unknown. Net reimbursement per transport increased 15.8% in the nine months ended September 30, 2012, compared to 2011, attributed to recent price increases. Provisions for contractual discounts and estimated uncompensated care related to patient transport revenue are as follows:

   
For quarters ended
September 30,
   
For nine months ended
 September 30,
 
   
2012
   
2011
   
2012
   
2011
 
Gross billings
    100 %     100 %     100 %     100 %
Provision for contractual discounts
    44 %     44 %     44 %     43 %
Provision for uncompensated care
    21 %     21 %     21 %     20 %

Although price increases generally increase the net reimbursement per transport from insurance payers, the amount per transport collectible from private patient payers, Medicare, and Medicaid does not increase proportionately with price increases. Therefore, depending upon overall payer mix, price increases will usually result in an increase in the percentage of uncollectible accounts. In addition, the number of transports covered by insurance decreased from 35.8% of total transports for the quarter ended September 30, 2011, to 35.5% of total transports for the quarter ended September 30, 2012, with most of the decrease moving to Medicare. Although we have not yet experienced significant increased limitations in the amount reimbursed by insurance companies, continued price increases may cause insurance companies to limit coverage for air medical transport to amounts less than our standard rates.

Aircraft maintenance. AMS 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 tend to be higher for aircraft which are no longer in production. Two models of aircraft within our fleet, representing 17% 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. Since January 1, 2011, we have taken delivery of 37 new aircraft. We have replaced discontinued models and other older aircraft with the new aircraft, as well as provided capacity for base expansion. Replacement models of aircraft typically have higher ownership costs than the models targeted for replacement but lower maintenance costs. Total maintenance expense increased 27.3% and 20.8% for the quarter and nine months ended September 30, 2012, respectively, compared to 2011. Total flight volume for all AMS operations increased 4.7% and 20.9% for the quarter and nine months ended September 30, 2012, respectively, compared to 2011. The change in maintenance expense reflects normal fluctuations in the timing of overhaul and replacement cycles for aircraft parts.
 
 
Competitive pressures from low-cost providers. We are recognized within the industry for our standard of service and our use of cabin-class aircraft. Many of our 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, we believe that higher quality standards help to differentiate our service from competitors and, therefore, lead to higher utilization.

Employee recruitment and relations. The ability to deliver quality services is partially dependent upon our 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. Our pilots are represented by a collective bargaining unit and are covered under a collective bargaining agreement (CBA) which is effective through December 31, 2013. Other employee groups may also elect to be represented by unions in the future.

Results of Operations

We reported net income of $27,844,000 and $71,731,000 for the quarter and nine months ended September 30, 2012, respectively, compared to $18,540,000 and $34,172,000 for the quarter and nine months ended September 30, 2011, respectively. The results for 2012 and for the third quarter of 2011 include the impact of the Omniflight acquisition which closed in August 2011. The third quarter of 2012 includes only one month of incremental net impact from Omniflight’s operations since the acquisition occurred on August 1, 2011. Net reimbursement per patient transport increased 13.9% and 15.8% in the quarter and nine months ended September 30, 2012, compared to 2011, while Same-Base Transports were 2.9% and 1.3% higher over the same periods, respectively.

Air Medical Services

Patient transport revenue is recorded net of provisions for contractual discounts and uncompensated care and increased $33,763,000, or 28.3%, and $151,368,000, or 52.8%, for the quarter and nine months ended September 30, 2012, respectively, compared to 2011, for the following reasons:
Incremental net revenue of $10,201,000 and $74,560,000 from Omniflight’s community-based services in the quarter and nine months ended September 30, 2012.
Increases of 13.9% and 15.8% in net reimbursement per transport for the quarter and nine months ended September 30, 2012, respectively, compared to 2011, due to the benefit of recent price increases net of the deterioration in payer mix described above.
Increases of 362, or 2.9%, and 400, or 1.3%, in Same-Base Transports for the quarter and nine months ended September 30, 2012, respectively, compared to 2011. Cancellations due to unfavorable weather conditions for locations open longer than one year were 172 and 2,177 lower in the quarter and nine months ended September 30, 2012, respectively, compared to 2011. Requests for community-based services increased 2.4% but decreased 2.3% for the quarter and nine months ended September 30, 2012, respectively, for bases open greater than one year.
Incremental net revenue of $4,031,000 and $20,985,000 for the quarter and nine months ended September 30, 2012, respectively, generated from the addition of eleven new bases, including six bases resulting from the conversion of hospital contracts, during either 2012 or 2011.
Closure of five bases and the conversion of one base back to hospital-based operations subsequent to September 30, 2011, due to insufficient flight volume, resulting in decreases in net revenue of approximately $3,128,000 and $5,524,000 during the quarter and nine months ended September 30, 2012, respectively.

 
Air medical services contract revenue increased $2,633,000, or 4.8%, and $15,225,000, or 9.9%, for the quarter and nine months ended September 30, 2012, for the following reasons:
Incremental net revenue of $2,030,000 and $13,694,000 from Omniflight’s air medical services contracts in the quarter and nine months ended September 30, 2012.
Cessation of service under five contracts and the conversion of two contracts to community-based operations, as well as the closure of certain satellite locations at the option of three current customers, during either 2012 or 2011, resulting in decreases in net revenue of approximately $5,239,000 and $15,495,000 for the quarter and nine months ended September 30, 2012, respectively.
Incremental net revenue of $4,152,000 and $9,847,000 for the quarter and nine months ended September 30, 2012, generated from the addition of two new air medical services contracts, the expansion of eight contracts to additional bases of operation, and the conversion of one community-based location back to hospital-based operations during either 2012 or 2011.
Decrease of 2.1% and increase of 1.2% in flight volume for the quarter and nine months ended September 30, 2012, respectively, for all contracts excluding Omniflight operations from January 1 through July 31, 2012; new contracts; contract expansions; and closed contracts.
Annual price increases in the majority of contracts based on stipulated contractual increases or changes in the Consumer Price Index or spare parts prices from aircraft manufacturers.

Flight center costs (consisting primarily of pilot, mechanic, and medical staff salaries and benefits) increased $10,772,000, or 15.3%, and $56,330,000, or 30.9%, for the quarter and nine months ended September 30, 2012, respectively, compared to 2011, for the following reasons:
Incremental flight center costs of approximately $5,996,000 and $41,613,000 related to Omniflight’s operations during the quarter and nine months ended September 30, 2012.
Increases of approximately $2,867,000 and $12,056,000 for the quarter and nine months ended September 30, 2012, respectively, for the addition of personnel to staff new base locations described above.
Decreases of approximately $3,188,000 and $7,539,000 for the quarter and nine months ended September 30, 2012, respectively, due to the closure of base locations described above.
Increases in salaries for merit pay raises.

Aircraft operating expenses increased $6,968,000, or 22.6%, and $22,054,000, or 24.8%, for the quarter and nine months ended September 30, 2012, respectively, compared to 2011. 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 change in costs is due to the following:
Increases in aircraft maintenance expense of $5,668,000, or 27.3%, to $26,403,000 for the third quarter of 2012 and $13,260,000, or 20.8%, to $77,004,000 for the nine months ended September 30, 2012, compared to the prior year. Total flight volume for AMS operations increased 4.7% and 20.9% for the quarter and nine months ended September 30, 2012, respectively, compared to prior year. The change in maintenance expense reflects normal fluctuations in the timing of overhaul and replacement cycles for aircraft parts.
Decrease of approximately 0.4% in the cost of aircraft fuel per hour flown for the third quarter of 2012 and increase of 2.7% for the nine months ended September 30, 2012. Total fuel costs increased $150,000 to $6,414,000 and $5,150,000 to $19,100,000 for the quarter and nine months ended September 30, 2012, respectively, compared to 2011. During both 2012 and 2011 we had commodity call options to protect against aircraft fuel price increases greater than 20%, covering essentially all of our fuel consumption for both years. Fuel expense included a non-cash mark to market derivative gain of $3,000 for the third quarter of 2012, compared to a loss of $528,000 for the third quarter of 2011, and a non-cash mark to market derivative loss of $239,000 for the nine months ended September 30, 2012, compared to a loss of $305,000 for the nine months ended September 30, 2011. Cash settlements under the terms of the agreement totaled $307,000 and $884,000 in the quarter and nine months ended September 30, 2011, respectively. We received no cash settlements under the agreement in the quarter and nine months ended September 30, 2012. Excluding the impact of the fuel derivative agreements, the cost of aircraft fuel per hour flown was 3.3% higher during the third quarter of 2012 but 2.7% lower during the nine months ended September 30, 2012, compared to 2011.
Decreases in hull insurance rates effective July 2012 and 2011.
Incremental aircraft operating expenses related to the Omniflight fleet were approximately $1,965,000 and $18,410,000 for the quarter and nine months ended September 30, 2012.
 

Medical Interiors and Products

Medical interiors and products revenue decreased $212,000, or 2.4%, and increased $1,194,000, or 5.4%, for the quarter and nine months ended September 30, 2012, respectively, compared to 2011. Significant projects in process during 2012 included fifty multi-mission interiors for the U.S. Army’s HH-60M helicopter and ten aircraft medical interiors for commercial customers. Revenue by product line for the quarter and nine months ended September 30, 2012, was as follows:
$4,562,000 and $10,794,000 – governmental entities
$3,928,000 and $12,444,000 – commercial customers
 
Significant projects in process during 2011 included work under two contracts to produce a total of fifty multi-mission interiors for the U.S. Army’s HH-60M helicopter, 77 interiors for an older generation of the U.S. Army’s Blackhawk helicopter, approximately 187 litter systems for the U.S. Army’s Medical Evacuation Vehicle, and six aircraft medical interiors for commercial customers. Revenue by product line for the quarter and nine months ended September 30, 2011, was as follows:
$5,748,000 and $15,537,000 – governmental entities
$2,954,000 and $6,507,000 – commercial customers
 
Cost of medical interiors and products decreased $187,000, or 3.1%, and increased $734,000, or 4.8%, for the quarter and nine months ended September 30, 2012, respectively, as compared to the prior year, due primarily to changes in sales volume and product mix. Costs in 2012 also included development and design work on aircraft interior configurations for commercial customers, leading to higher engineering and certification costs and to lower profit margins.

General Expenses

Depreciation and amortization expense increased $1,608,000, or 8.4%, and $10,243,000, or 19.6%, for the quarter and nine months ended September 30, 2012, compared to 2011. Incremental depreciation related to Omniflight’s fixed assets, including aircraft under capital leases, was approximately $740,000 and $5,547,000 and incremental amortization of Omniflight’s intangible assets was $329,000 and $2,301,000 for the quarter and nine months ended September 30, 2012, respectively. In addition, from the fourth quarter of 2011 through the third quarter of 2012, we added 27 aircraft subject to capital leases, totaling approximately $54.6 million, to our depreciable assets.

General and administrative (G&A) expenses increased $147,000, or 0.6%, and $13,564,000, or 22.5%, for the quarter and nine months ended September 30, 2012, respectively, compared to 2011, reflecting additional headcount required to manage increased operations as a result of the Omniflight acquisition. G&A expenses include executive management, accounting and finance, billing and collections, information services, human resources, aviation management, pilot training, dispatch and communications, and AMS regional administration. G&A expenses were 10.6% and 11.6% of revenue for the quarter and nine months ended September 30, 2012, compared to 12.6% and 12.9% of revenue for the quarter and nine months ended September 30, 2011. During the first quarter of 2012, we completed the consolidation of the Part 135 Air Carrier Certificate for Omniflight into the Air Methods certificate and completed the process of integrating other Omniflight overhead functions into existing departments. G&A expenses for the quarter and nine months ended September 30, 2012, also included $1,527,000 and $6,877,000, respectively, for severance related to the elimination of the chief operating officer position and incentive compensation accruals related to our financial performance. Expense related to incentive compensation totaled approximately $992,000 and $2,564,000 in the quarter and nine months ended September 30, 2011, respectively. Expenses for the quarter and nine months ended September 30, 2011, also included approximately $1,509,000 and $1,759,000 in transaction costs and employee severance related to the acquisition of Omniflight.

 
Interest expense decreased $361,000, or 6.7%, and increased $1,683,000, or 11.8%, for the quarter and nine months ended September 30, 2012, compared to the quarter and nine months ended September 30, 2011. The increase in the nine-month period is primarily due to interest recorded on capital lease obligations, totaling approximately $26.0 million as of September 30, 2012, assumed in the Omniflight acquisition and to interest incurred on the $200 million term loan originated to fund the acquisition of Omniflight. The term loan bears interest at a variable rate which averaged 2.3% for the nine months ended September 30, 2012. In addition, we carried average balances of $23.8 million and $22.0 million against our line of credit during the quarter and nine months ended September 30, 2012, respectively, compared to no borrowings against our line in the nine months ended September 30, 2011. The line of credit bears interest at a variable rate which averaged 3.2% for the nine months ended September 30, 2012. These increases were offset entirely during the third quarter by the effect of reduction in principal balances for long-term debt and capital lease obligations as a result of regularly scheduled payments; lease buyouts relating to obligations totaling $39.4 million during the nine months ended September 30, 2012; and the payoff of our previous $50 million term loan in July 2011.

Income tax expense was $19,073,000 and $46,551,000, at effective tax rates of 40.7%, and 39.4%, for the quarter and nine months ended September 30, 2012, respectively, compared to $12,616,000 and $22,783,000, at effective tax rates of 40.5% and 40.0%, for the quarter and nine months ended September 30, 2011, respectively. The rate in 2012 was affected by apportionment factor adjustments which increased our expected blended state rate; applying the new rate to deferred tax assets and liabilities resulted in income tax expense of $667,000 for the quarter and nine months ended September 30, 2012. Excluding the effect of this change, the effective tax rate was 39.2% and 38.8% for the quarter and nine months ended September 30, 2012, respectively. The decrease in this revised rate compared to 2011 is primarily the result of a decrease in certain permanent book-tax differences. Changes in our effective tax rate are affected by the apportionment of revenue and income before taxes for the various jurisdictions in which we operate and by changing tax laws and regulations in those jurisdictions.

Liquidity and Capital Resources

Our working capital position as of September 30, 2012, was $174,330,000, compared to $85,011,000 at December 31, 2011. Cash generated by operations was $96,331,000 in 2012, compared to $54,304,000 in 2011, reflecting the improvement in operations described above. In 2012, we have increased our accrual for current income taxes payable by approximately $7.2 million based on estimated 2012 taxable income, net of quarterly estimated payments already made. Days’ sales outstanding (DSO’s) for community-based services, measured by comparing net patient transport revenue for the annualized previous 3-month period to outstanding open net accounts receivable, increased from 94 days at December 31, 2011, to 107 days at September 30, 2012. DSO’s as of September 30, 2011, were 92 days. We believe that the increase in DSO’s is primarily related to delays in the internal payer verification process during the third quarter of 2012, which have been mitigated since quarter-end.

Cash used by investing activities totaled $31,453,000 in 2012 compared to $229,364,000 in 2011. In addition to the working capital adjustment of $3.2 million to the purchase price for Omniflight, equipment acquisitions in 2012 included the buy-out of 34 previously leased aircraft for approximately $52.3 million. Five of these aircraft were subsequently sold for approximately $21.1 million and leased back under capital leases. We also sold ten other aircraft for $8.9 million during 2012. In addition to the purchases of Omniflight and URS, equipment acquisitions in 2011 included the buy-out of sixteen previously leased aircraft for approximately $17.4 million. We sold five aircraft for $5.9 million during 2011.

Financing activities used $64,633,000 in 2012 compared to providing $116,865,000 in 2011. The primary uses of cash in both 2012 and 2011 were regularly scheduled payments of long-term debt and capital lease obligations and capital lease buy-outs. Lease buy-outs of $39.4 million in 2012 were funded primarily through borrowings under our line of credit and cash from current operations. In 2011 we used cash reserves to retire our previous term loan and proceeds from the $200 million term loan under our Amended Credit Facility to fund the acquisition of Omniflight.
 

Critical Accounting Policies

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.

On an on-going basis, management evaluates our estimates and judgments, including those related to revenue recognition, deferred income taxes, and valuation of long-lived assets and goodwill. 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 our consolidated financial statements.

Revenue Recognition

Fixed hospital contract  revenue under our operating agreements with hospitals is recognized monthly over the terms of the agreements. Revenue relating to patient transports is recognized upon completion of the services and is recorded net of provisions for contractual discounts and estimated uncompensated care. Both provisions are estimated during the period related services are performed based on historical collection experience and any known trends or changes in reimbursement rate schedules and payer mix. The provisions are adjusted as required based on actual collections in subsequent periods. We have from time to time experienced delays in reimbursement from third-party payers. In addition, third-party payers may disallow, in whole or in part, claims for reimbursement based on determinations that certain amounts are not reimbursable under plan coverage, determinations of medical necessity, or the need for additional information. Laws and regulations governing Medicare and Medicaid programs are very complex and subject to interpretation. We also provide services to patients who have no insurance or other third-party payer coverage. There can be no guarantee that we will continue to experience the same collection rates that we have in the past. If actual future collections are more or less than those projected by management, adjustments to allowances for contractual discounts and uncompensated care may be required. Based on related patient transport revenue for the nine months ended September 30, 2012, a change of 100 basis points in the percentage of estimated contractual discounts and uncompensated care would have resulted in a change of approximately $12,428,000 in patient transport 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. We estimate 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.
 

Deferred Income Taxes

In preparation of the consolidated financial statements, we are required to estimate income taxes in each of the jurisdictions in which we operate. 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. We then assess the likelihood that deferred tax assets will be recoverable from future taxable income and record a valuation allowance for those amounts we believe are not likely to be realized. We consider 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. Establishing or increasing a valuation allowance in a period increases income tax expense. In the event we were to determine that we would not be able to realize all or part of our 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 we determine that we would be able to realize our deferred tax assets in the future in excess of our net recorded amount, an adjustment to the valuation allowance would increase income in the period such determination was made. The effect on deferred income tax assets and liabilities of a change in statutory tax rates applicable to the Company is also recognized in income in the period of the change. We evaluate the recognition and measurement of uncertain tax positions based on the facts and circumstances surrounding the tax position and applicable tax law and other tax pronouncements. Changes in our estimates of uncertain tax positions would be recognized as an adjustment to income tax expense in the period of the change.

Long-lived Assets Valuation

In accounting for long-lived assets, we make estimates about the expected useful lives, projected residual values and the potential for impairment. Estimates of useful lives and residual values of aircraft are based upon actual industry experience with the same or similar aircraft types and anticipated utilization of the aircraft. Changing market prices of new and used aircraft, government regulations and changes in our maintenance program or operations could  result in changes to these estimates. Long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of long-lived assets is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. Our cash flow estimates are based on historical results adjusted for estimated current industry trends, the economy, and operating conditions.

Goodwill Valuation

The Company’s goodwill relates to six acquisitions and has been allocated to our operating segments. During the first quarter of 2012, we adopted ASU No. 2011-08, Testing for Goodwill Impairment, which allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. Under this ASU, when we perform our annual goodwill assessment at December 31, we will not be required to calculate the fair value of a reporting unit unless we determine, based on a qualitative assessment, that it is more likely than not that its fair value is less than its carrying amount.

Because ASU No. 2011-08 had not been adopted as of December 31, 2011, we evaluated goodwill for potential impairment using the two-step test at the reporting unit level. The first step of the goodwill impairment test compares the book value of a reporting unit, including goodwill, with its fair value. If the book value of a reporting unit exceeds its fair value, we perform the second step of the impairment test to determine the amount of goodwill impairment loss to be recorded. In the second step, the implied fair value of the reporting unit’s goodwill is compared to the book value of the goodwill. The amount of impairment loss is equal to the excess of the book value of the goodwill over the implied fair value of that goodwill.

We determine the fair value of each reporting unit based upon the reporting unit’s historical operating profit and the Company’s current public trading value. Estimated future operating profit for each reporting unit is also taken into consideration when determining the reporting unit’s fair value. Considerable management judgment is necessary to evaluate the impact of economic changes and to estimate future operating profit for the reporting units. Assumptions used in our impairment evaluations, such as forecasted growth rates and patient receivable collection rates, are based on the best available market information and are consistent with our internal forecasts. Changes in these estimates or a continued decline in general economic conditions could change our conclusion regarding an impairment of goodwill and potentially result in a non-cash impairment loss in a future period.

The estimated fair values of the reporting units have historically exceeded the carrying values of the reporting units. We performed a sensitivity analysis on the Company’s public trading value and on each reporting unit’s historical and estimated future operating profits. Based on the amounts used in the evaluation of goodwill at December 31, 2011, either the Company’s current public trading value or any reporting unit’s operating profit would have to decrease by more than 61% before the carrying value of the reporting unit exceeded its fair value.
 
 
Item 3.
Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in market risk at September 30, 2012, from that reported in our Annual Report on Form 10-K for the year ended December 31, 2011.
 
Item 4.
Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted to the Securities and Exchange Commission (the Commission) under the Securities Exchange Act of 1934, as amended (the Exchange Act), is recorded, processed, summarized and reported within the time periods specified by the Commission’s rules and forms, and that information is accumulated and communicated to management, including the principal executive and financial officers (referred to in this report as the Certifying Officers), as appropriate to allow timely decisions regarding required disclosure. Management, under the supervision and with the participation of the Certifying Officers, evaluated the effectiveness of disclosure controls and procedures as of September 30, 2012, pursuant to Rule 13a-15(b) under the Exchange Act. Based on that evaluation, the Certifying Officers have concluded that, as of September 30, 2012, our disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There were no significant changes in our internal control over financial reporting that occurred during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
 
PART II: OTHER INFORMATION

Item 1.
Legal Proceedings

Not Applicable

Item 1A.
Risk Factors

There have been no material changes in our risk factors from those disclosed in our annual report on Form 10-K for the year ended December 31, 2011, except as follows:

Healthcare reform – In June 2012, the United States Supreme Court upheld the constitutionality of most of the provisions of the Patient Protection and Affordable Care Act (PPACA). Most of the provisions designed to increase access to health benefits for the uninsured or underinsured populations are not scheduled to take effect until 2014. A high degree of uncertainty exists regarding the impact of the PPACA on our collection rates. To the extent uninsured patients obtain any type of insurance coverage, our collection rates may increase. To the extent patients currently covered by private insurance move to government-run programs or to proposed public insurance exchanges, collection rates may decrease. Government-run programs, such as Medicare and Medicaid, may also impose additional discounts in determining their reimbursement rates to offset the cost of expanding coverage to a greater number of participants. In addition, states are allowed to opt out of the Medicaid expansion, which may limit the number of uninsured patients which receive coverage.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

Not Applicable

Item 3.
Defaults upon Senior Securities

Not Applicable

Item 4.
Mine Safety Disclosures

Not Applicable
 
 
22

 
 
Item 5.
Other Information
 
On November 8, 2012, the Board of Directors approved the Company’s First Amended and Restated Bylaws, effective immediately upon adoption. The amendments comprise general updates to the Bylaws and include the following:
 
·  
Amendments to Article IV to provide a conduct of business provision for committees of the Board of Directors, including quorum requirements, vote requirements and ability to take action by consent in writing or by electronic transmission.
·  
Amendments to Article V, including:
 
·  
Amendments to Section 1 to limit the Company’s required officers to a president, a chief executive officer and a secretary, and provide the Board of Directors with discretion in additional officer positions; and
 
·  
Amendments to Section 2 to add standard removal, resignation and vacancy provisions relating to officer positions.
·  
Amendments to Article VI, including:
 
·  
Addition of Section 3 providing for the right of an indemnitee to bring suit against the Company to recover any unpaid claim for indemnification;
 
·  
Addition of Section 4 explicitly providing that the rights to indemnification and advancement of expenses set forth in the Bylaws are not exclusive rights;
 
·  
Addition of Section 5 providing for the Company’s option to maintain insurance protecting directors, officers, employees and agents for expenses, liabilities or losses;
 
·  
Addition of Section 7 providing for indemnification against expenses incurred in connection with any director, officer, employee or agent’s participation as a witness in any proceeding based on his or her position with the Company; and
 
·  
Addition of Section 8 providing for ability to enter into indemnification agreements with any director, officer, employee or agent of the Company.
·  
Addition of Article VII to add standard provisions with respect to the Company’s stock certificates, transfers of stock, setting of record dates and lost or destroyed stock certificates.
·  
Addition of Article IX to add standard provisions regarding the Company’s corporate seal, ability to rely on the Company’s books and records and the Company’s fiscal year.
·  
Certain other technical and clarifying amendments to matters of administration and process.
 
The foregoing is a summary of the amendments made to the Company’s Bylaws. This summary is qualified in its entirety by reference to full text of the First Amended and Restated Bylaws dated November 8, 2012, a copy of which is attached as an exhibit hereto and incorporated herein by reference.
 
Item 6.
Exhibits
 
3.1 First Amended and Restated Bylaws
   
Chief Executive Officer Certification adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
Chief Financial Officer Certification adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
   
Certification adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   
101.INS
XBRL Instance Document
   
101.SCH  
XBRL Taxonomy Extension Schema Document
   
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
   
101.LAB
XBRL Taxonomy Extension Label Linkbase Document
   
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document


SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
AIR METHODS CORPORATION
 
       
Date:  November 9, 2012
By
/s/ Aaron D. Todd
 
   
Aaron D. Todd
 
   
Chief Executive Officer
 
       
Date:  November 9, 2012
By
/s/ Trent J. Carman
 
   
Trent J. Carman
 
   
Chief Financial Officer
 
       
Date:  November 9, 2012
By
/s/ Sharon J. Keck
 
   
Sharon J. Keck
 
   
Chief Accounting Officer
 
 
 
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