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Air Methods Corporation (NASDAQ:AIRM)

Q3 2008 Earnings Call Transcript

November 6, 2008, 4:15 pm ET

Executives

Christine Clark – IR

Aaron Todd – CEO

Trent Carman – CFO, Secretary and Treasurer

Analysts

Bob Labick – CJS Securities

Ryan Daniels – William Blair & Co.

Kevin Campbell – Avondale Partners

Greg Williams – Sidoti & Co.

Charles Griege – Blue Lion Capital

David Bachman – Longbow Research

Operator

Good afternoon. My name is Ashley, and I will be your conference operator today. At this time, I would like to welcome everyone to the Air Methods Third Quarter 2008 Financial Results Conference Call. (Operator instructions) Ms. Clark, you may begin your conference.

Christine Clark

Thank you. Good afternoon. Thank you for joining us today to review Air Methods’ third quarter financial results, ended September 30, 2008. As the Operator indicated, my name is Christine Clark, and I am with Air Methods Corporation. With us today on the call representing the company are Mr. Aaron Todd, Chief Executive Officer, and Mr. Trent Carman, Chief Financial Officer. At the conclusion of today’s prepared remarks, we will open the call for a question and answer session.

I would like to remind everyone this conference call includes statements that constitute forward-looking statements within the meanings of the Private Securities Litigation Reform Act of 1995. This conference call includes certain forward-looking statements, which are subject to various risks and uncertainties.

Actual results could differ materially from those currently anticipated, due to a number of factors, including, but not limited to, the integration of CJ into the existing operation, the size, structure, and growth of the company’s air medical services and products markets, the collection rate for patient transports, the continuation and/or renewal of air medical service contracts, the acquisition of profitable product division contracts and other flight service operations, the successful expansion of the community-based operations, and other matters set forth in the company’s public filings.

With that having been said, I would like to turn the call over to Mr. Aaron Todd, Chief Executive Officer of Air Methods Corporation.

Aaron Todd

Thanks, Christine, and thanks to all of you for joining us today on our conference call. Trent’s going to offer added details and insights into our third quarter financial results in a moment. I thought I would spend some time highlighting recent events and activities that have relevance for our future periods.

First, estimated average cost per gallon of fuel during our second and third quarters was approximately $5.50 per gallon. Estimated October average is expected to be approximately $4.40, with further reductions expected based on anticipated full effect of October price decreases. Total fuel expense year-to-date through September was approximately $13.6 million for our community-based operations. Current cost per gallon is now below the average level for each of the last four quarters, or as compared to those four quarters.

As mentioned in our press release, the company generated $44.3 million in cash flows from operating activities through the first nine months of 2008. From this amount, long-term debt net of cash was reduced by $14.5 million, the company used an additional $16.5 million to buyout leased aircraft, which remained unencumbered, and finally, an additional $2.9 million was used to buy back 100,000 shares of company stock during the third quarter.

Upon completion of pending financings and collection of FEMA receivable from the hurricane response activities over the next few weeks, the company’s $50 million line of credit will become fully paid, based on recent balance. In addition, the company has over $50 million in owned aircraft which are either unencumbered or fair market value exceeds debt balance.

The company also has significant equity in its leased aircraft, based on current buyout options. Accordingly, the company currently enjoys a strong liquidity and financeable asset position and positive cash flows. We anticipate continuation of our stock repurchase activities, based on current status of our balance sheet and access to asset-based financing.

We have now converted eight twin-engine aircraft to single-engine operations during the first nine months of 2008, within our community-based operation. Each of these conversions can reduce annual operating expenses from between $500,000 and $750,000 annually. We have identified eight additional twin engine locations within our community based operations that will be converted to single engine as soon as the new aircraft arrive and are made ready for service. Additional twin engine locations will be evaluated in the future for possible conversion as well.

As was mentioned in our two recent press releases, our products division has secured new contracts that now bring their backlog position to over $30 million. Based on annualized nine-month external revenue in 2008, this current backlog represents 2.5 times annualized revenue, suggesting strong growth outlook in 2009 and beyond.

Continued improvement in our net revenue per transport gives us continued justification to increase pricing on at least a semiannual basis. We currently anticipate that our next price increase will take effect on January 1st, 2009.

On October 1, Air Methods acquired its corporate facility from its landlord. While this will increase our debt position by approximately $7 million, it will reduce our facility lease expense by a little less than $1 million annually.

In updating our payer mix data as of the end of the third quarter, we have not seen any material movement in payer mix thus far.

Many of you have asked what impact the hurricane response had on our Same-Base Transports during the third quarter. It is difficult to determine, since the hurricanes also impacted call volumes once they came on shore.

Since the majority of this activity occurred in September, comparing changes in August to September flight volume in 2008 versus 2007 might offer some perspective. There was 161 transport reductions in September 2007 versus August 2007. The decrease from August to September in 2008 was 538 transports, for a difference of 377 transports.

However, based on tracking missed calls from deployed bases, the missed transports themselves were approximately 100. Therefore, the actual net impact is probably between these two numbers, when factoring in both impact of hurricanes on call volume and missed flights due to redeployed aircraft, and again, those two numbers would be somewhere between 100 and 377 transports.

To summarize, uncertainties concerning the general economic environment on flight volume demand and payer mix continue to exist. However, we remain optimistic that lower fuel prices, expected increased reimbursement from future price increases, expectation for more favorable weather cancellations in coming months, eventual moderation in maintenance expenditures, cost reductions from transitioning twin engine aircraft to single engine shifts, and the full-year benefit of our fully integrated CJ operations should favorably affect our net results in coming quarters.

In addition, President-Elect Obama’s current health care plan, which requires all children to have coverage, proposes employer mandates, and offers subsidies to individuals to access public or private plans, could have a favorable and significant impact on reducing our percentage of patients with no coverage, which currently runs between 14% and 15%. While obviously there’s no assurance as to whether those plans will be forthcoming or what timeframe they may take, certainly anything that would improve the number of uninsured patients that we transport would have a disproportionate benefit to our bottom line.

With those specific points of update, I will now turn the call over to Trent Carman for a more detailed summary of our third quarter results.

Trent Carman

Thank you, Aaron. As we reported in today’s press release, revenue, net income, and earnings per share for the third quarter were $133.8 million, $8.4 million, and $0.67 per share respectively. Revenue generated by our CBS division grew $13.3 million during the third quarter.

The acquisition of CJ Systems on October 1 of last year contributed $10.8 million of the increase. The remaining increase in CBS revenue relates to flight volumes from newly opened bases and to an increase in our net revenue per transport and to some of the FEMA revenue Aaron mentioned previously.

Revenues generated by our HBS division grew $19.2 million during this same quarter. The acquisition of CJ Systems contributed $15.9 million to this increase. The remaining increase in HBS revenue related primarily to new bases and to annual price increases.

General and administrative expenses increased by approximately $3 million for the third quarter of 2008, as compared to the third quarter of 2007. The majority of this increase relates to additional staffing required by the CJ acquisition. General and administrative expenses actually decreased $1.6 million during the third quarter as compared to the second quarter of 2008, primarily due to the non-recurring training and other expenditures discussed in last quarter’s conference call.

Earnings before interest, income tax, depreciation, and amortization, or EBITDA, were $18.4 million, and $23.1 million, for the third quarters of 2008 and 2007, respectively. On a trailing 12 basis, our EBITDA was approximately $54 million. You can reconcile EBITDA by adding interest expense, depreciation, and amortization, gains and losses from disposition of assets and loss on the extinguishment of debt, to income before income tax expense.

Our net current position, which is current assets less current liabilities, was approximately $106 million at September 30, and our stockholders’ equity was $158 million. The company’s net debt position, which is a total of all indebtedness less cash was $75.5 million at September 30, and $90 million at December 31, 2007. At September 30, the company had approximately $31 million of excess availability under its revolving line of credit. During 2008, the weighted-average interest rate on our variable rate debt has decreased by over 300 basis points as compared to 2007.

So far during 2008, we have refinanced 17 aircraft and have bought out 20 aircraft leases. We have sold 12 aircraft during 2008 for net cash proceeds of $14 million. Our day sales outstanding at September 30th were 106 days. This compares to 110 days at June 30th and 108 days at December 31st, 2007.

Many of you recently asked if we are in compliance with our bank covenants, based upon our recent press release. At September 30th and other times during 2008, we have maintained compliance with all of our bank covenants. The company currently operates 314 aircraft in our fleet. Of those, 180 aircraft were in our hospital-based division and 134 were in our community-based division. Additionally, the company operates 99 community bases and 155 hospital bases.

With that, I’ll turn the call over to Aaron for his closing remarks.

Aaron Todd

Well, actually, we’re going to open it up to questions. So, Operator, if you would open it up for questions at this time, we would appreciate it.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Bob Labick, with CJS Securities.

Bob Labick – CJS Securities

Good afternoon.

Aaron Todd

Hi, Bob.

Bob Labick – CJS Securities

Hi, a couple questions. First, I wanted to touch on Same-Base Transports, and I am trying to do this quickly, obviously, but if you take out weather and the hurricane impact that you gave us a range for, it might have been down in the 9% to 10% range in October appears to be, if you back out weather maybe 8%-ish, so it appears to be improving a little bit, but it’s still a big number, and I think miles driven and accidents on the highways is probably the main driver there. Could you tell us what the other drivers are, and what you’re seeing in those trends?

Aaron Todd

Well, we know that certainly, miles driven is a key factor. It’s kind of hard to estimate perfectly, but somewhere between 50% to 60% of our transports are directly or indirectly related to road travel, so any reduction in miles driven is going to have a commensurate impact, and certainly over the summer months, with the spike in fuel prices and certainly softness in the economy, the Department of Transportation was showing mid-to-high single digit reductions in total miles driven by Americans on rural highways and in totality, so we know that’s having some impact.

The hope would be that with the fairly significant reductions in fuel prices, we’ll start to see some restoration of road travel that, obviously, has a bearing on the demand for our service. Certainly, as we’ve talked with many of our hospital customers, they certainly are experiencing a reduction in ER admissions, just generally speaking.

So there is also, I’m sure, a component of that softness that’s related to just a lower activity level within the US population as the economy slows, but certainly, I think it’s fair to say that we saw a bottoming out in September and we started to see some improvement, some of that obviously was weather-related and it’s hard to say, but I think we’ll still see some softness in Same-Base Transports for a season while we see how quickly lower fuel prices has an impact, and to what extent.

I think the good news, as we mentioned is that we also are going through pretty easy comp months relative to weather cancellations as was evidenced in October as that significantly improved our Same-Base Transports were only down 4.5% partly because of improved weather cancellation variances.

December, for example, last year, was the weakest month in the entire 2007 and was very severe and so certainly those factors hopefully will have some offset should there continue to be softness in flight demand associated with these other factors.

Bob Labick – CJS Securities

Great. That’s very helpful and then turning to the HBS side, two questions, I guess. First, could you just give us a status on contract renewal and updates and where you expect margins should they be normalizing on those and then the second one, if you could just talk about the maintenance in the quarter and expectations on that on either side going forward?

Aaron Todd

Yes, we have done that. We did an analysis of all of our contracts, those that have been renewed over the last couple of years, and they’re performing right pretty much to expectation. We continue to have all the CJ contract so that, we still need to go through the renewal process with and get some of those normalized. So, we’re very comfortable that the renewals are driving our objectives, and we would hope to achieve about a 10% segment net income profile as a percentage of revenue, as we get everything through the renewal process.

Since our last conference call, we’ve actually had one new customer that has given us a verbal commitment up in Alaska for two locations to begin operations in January, and we had one customer involving one location that chose to no longer be in this service but to outsource it, and we will not be providing service in that market, so we’re a net positive one since our last conference call.

Certainly the earnings profile there has largely been attributed as volume has declined a bit, maintenance did not kind of decline, in fact it was higher, as was reflected in our release, so, as, again, we’re not very good, obviously, at predicting quarter-to-quarter, but certainly we would continue to anticipate moderation in maintenance expenditures and then more importantly, that we would get market-to-market pricing once these contracts come up for renewal, and would expect improvement in margins as we go through that process.

Bob Labick – CJS Securities

Okay, great and then, just, globally, looking at the industry, obviously, given the miles driven and the slower demand right now, your competitors must be as impacted as well. Could you just talk about if anything is going on out there with competitors? Are they closing bases?

Aaron Todd

We know that one of our competitors closed a couple of bases in Virginia. We hear a lot of rumors out there in other locations, but, and I’m sure there has been some consolidations I’m just not aware of, but yes, there has been a move on the part of some of our competitors to look for consolidation of bases to improve utilization, as have we done some of that, and we’ll continue to look at those possibilities where if you have some softness in demand, you can consolidate bases and sometimes even come out better than you were before, so we’ll continue to monitor that closely.

We have seen a little bit of that, but it has certainly not been anything major at this point. I’m not aware of any of our competitors saying, “Boy, volume has never been greater.” I think all have acknowledged that they have experienced softness, but certainly they have not given us specifics. I’m sure their financial report is coming out in the next day or two, and there may be some benchmark data in that report.

Bob Labick – CJS Securities

Okay, great. Thank you very much. I will get back in the queue.

Aaron Todd

Thanks Bob.

Operator

Our next question comes from the line of Ryan Daniels with William Blair.

Ryan Daniels – William Blair & Co.

Yes, good afternoon guys, a couple of quick questions. First off you discussed Aaron at the start of the conference call in your comments about the fuel cost. Obviously they have come down, and you probably don’t see a ton of benefit from that in the quarter, but that should continue, and I’m curious. If fuel would just stay where it is today, what kind of impact that might have on the earnings line if you look at 2009? Year-over-year, what kind of growth that would allow just in and of itself?

Aaron Todd

Well, they’re still coming down, and I haven’t actually looked at a point in time. I know that we were up 58% year-over-year predominantly driven by what occurred in the second and third quarter. We actually got no benefit in our third quarter from reductions because it spiked in July and then came down in late September, and it kind of averaged out to be close to what it was in the second quarter, which was a 58% increase for the nine-month period. Certainly the fourth quarter and first quarter of next year already had some hardening of amounts, but it wasn’t as high.

We estimate that through the nine months, if you use a $4.40 per gallon level, that there would be about $5 million of savings there and certainly we are continuing to see it go down below the average in October. So, probably at these levels, $60 a barrel, you’re probably looking at an annualized benefit over the next four quarters in that probably $5 million to $7 million range.

Ryan Daniels – William Blair & Co.

Okay. That’s actually pretty significant to earnings, then.

Aaron Todd

It is.

Trent Carman

That would be pre-tax, of course.

Aaron Todd

That’s pre-tax, but of course, I mean it’s directly to the bottom line, as they say.

Ryan Daniels – William Blair & Co.

Then there has been a lot of discussion lately, including the NTSB meeting, I think, a few weeks ago about air medical safety and potential changes, and I’m curious about what your thoughts are on things that could be potentially happen in any of those that you would strongly agree with or disagree with that could negatively impact the business. I know you’re already doing a lot of that with the night-vision goggles and terrain awareness and kind of status updates on your flights, but anything out there that either worries you or could impact business if it does come to fruition?

Aaron Todd

Well, certainly the FAA is considering certain modifications to the operating specifications for HEMS operators. We actually got through with a conference call yesterday afternoon proposing certain changes that represent elevations to the weather minimum, but we were already operating at above FAA minimum, so there would be maybe some impact to other operators, but a fairly minimal impact to our operation, since we were already operating at a higher min. They have embraced, at least informally, our recommendations, and certainly it has incentives to bring night-vision goggles and TAWS into everyone’s operations. As you know, we’re already well down that path.

So, at this point in time, I’m not aware of anything that would adversely affect us directly. However, nothing’s definitive at this point in time. Nothing is finalized, and certainly there could be other changes that could have a negative impact on either the cost of our operations or our ability to fly in certain environments, but at this point in time, I think the FAA acknowledges that they don’t want to do anything arbitrary or capricious or draconian, and are trying to work together with the operators who obviously want to stem the tide of recent events and see real improvement.

But we remain very optimistic that night-vision goggles, TAWS, those things that will help to reduce the margin for error and reduce the risks relative to night-flying conditions and adverse-weather conditions, is obviously what everybody is focused on, and that being said, the NTSB will continue, I’m sure, to put pressure on the FAA to do whatever is needed to improve things and whenever there is an accident whether it’s air methods or otherwise, it affects everyone.

Ryan Daniels – William Blair & Co.

No, that’s extremely helpful color. Two more and I’ll hop off. First off, on the cash flow, if I’m doing my math right, it looks like during the third quarter it was about $21 million, which is probably one of the strongest quarters I think we’ve ever seen. Was there anything unusual there driving the strength in your cash flows during the period?

Aaron Todd

Well, not really. I mean, reimbursements are doing well. I know we’re seeing economic slowdowns, but our payer mix is really holding well, and one possibility, please don’t latch on to this, but it’s possible that some of the softness in the flight volume is disproportionate to those who would not have had insurance anyway. So, in other words, our payer mix is holding. Now, again, that’s lagged 90 days, so essentially we’re only really seeing true mix through June of 2008, but through June of 2008 we have not seen a material shift in payer mix, and reimbursement has remained strong. So, collections have been good.

Keep in mind it would have been even stronger had we collected the $7.4 million FEMA bill by the end of September. The bill just went out a couple of weeks ago, but adding that into the mix is going to create a nice uptick for operating cash flow as well. We get a lot of questions, “Despite some of the softness in earnings, are you still positively cash flowing?” And the answer is, absolutely. We’re – we’ve managed that fairly well.

Ryan Daniels – William Blair & Co.

Sure. Okay, great and then the last one, it kind of leads in nicely with the strength in your cash flows. I’m just curious from a corporate philosophy standpoint how you think of uses of cash. It sounds like you bought your HQ, you bought some assets, you paid down some debt, you bought shares, you really use cash for a lot of different things, and I’m curious what your priorities are, particularly where the stock is today, and given some of the volatility in the business, if that becomes more attractive or just any thoughts there would be really helpful. Thanks.

Aaron Todd

I think the only shift at this point in time is, where we were using three primary purposes for free cash flow that was debt pay down, buying out leased aircraft to make them unencumbered and buying back shares, we’re probably going to focus on just the two, which is debt retirement and share buyback.

I think at these valuations, again, obviously, we thought it was pretty attractively priced in the upper 20s. We continue to believe that retiring shares at these valuations makes sense. Obviously, Trent is continuing to make sure that we’ve got plenty of cushions relative to the debt covenants and the we don’t put ourselves close to any edges, but certainly with the free cash flow that we are generating those would be the top two priorities at this point.

Ryan Daniels – William Blair & Co.

Okay. Thanks a lot for the color, guys.

Trent Carman

Ryan, just to follow up there, on the purchase of the building, we are going to put a mortgage in place very shortly on the property, so that will be encumbered. We did buy it out from our lease. So there will be proceeds from that financing.

Ryan Daniels – William Blair & Co.

Okay, perfect. Thanks again, guys.

Aaron Todd

Thank you.

Operator

Our next question comes from the line of Kevin Campbell with Avondale Partners.

Kevin Campbell – Avondale Partners

Good afternoon. I was hoping you guys could talk a little bit more about the Same-Base Transports and the volume weakness there. I guess Bob had given some numbers earlier – he had calculated, and I haven’t yet had a chance to do it, but sort of roughly 9% to 10% down for the quarter and then 8% for October. Are those numbers consistent with what you would have calculated.

Aaron Todd

I guess I don’t know what you’re…

Kevin Campbell – Avondale Partners

What I’m trying to get at is, after you adjust for weather, weather increases or decreases cancellations, what would the Same-Base Transport volumes or contractions have been? It looks like it was 5%.

Aaron Todd

Well, let me just give you the actual numbers. I mean, your transport number went down 163 transports against adjusted prior-year Same-Base Transports of 3558. I think that works out to be about 4.5%, but then you had about roughly 300 fewer weather cancellations, which would put you into the low double-digits on, shall we say, core softness in demand.

Now, you’ve got to be a little bit careful about just adding or subtracting in weather cancellations, because just because a cancellation doesn’t go down or goes up doesn’t mean it would have reflected a true increase or a completed transport, but we were down around 20% in September x-weather, and we’re down probably in that – I haven’t done it, you can do the calculation, but it’s in the low double-digit percentage decrease.

Again, I think we’re seeing some softness in that 10% range on average. That’s pretty close to what we were seeing on the hospital-based side during the third quarter as well, and I guess the real question is going to be how quickly that recovers. The other thing we have to ask ourselves is, will it be as severe in the winter months, and a lot of discretionary travel is down in the winter months anyway. Fuel prices are down, but the economy is still very weak.

So again, we would expect it to be down. I think our hope would be that it would moderate into that 5% range, but either way, we know we’re going to pick up quite a few transports, well we don’t know, but we would expect to pick up quite a few additional transports with fewer weather cancellations since the prior-year comps, the prior-year levels of weather cancellations were extremely high.

Kevin Campbell – Avondale Partners

Right, okay and then you had mentioned the aircraft that you had purchased the leases on. What should that do to lease expense going forward or maybe you can tell us, I don’t think the queue is out already, but you did $11.7 million in aircraft rental expense in the second quarter? What was it in the third, and should it come down in the fourth because of some of these buyouts?

Aaron Todd

Keep in mind we still have some aircraft coming in that’s rejuvenating the fleet, so it’s going to be hard just to do a comparative, but we had rental expense of $12.3 million in the three months ended September 30th, 2008, for aircraft rental.

Kevin Campbell – Avondale Partners

Okay, so it’s going to be tough, it’s not going down obviously because of the….

Aaron Todd

If you look at net payoffs, and I think it was roughly $16 million that were unencumbered as of September 30th, you can usually use nine-tenth of a percent of that number, so that would be roughly 100,000 times 3, it would be about $1.2 million in reduced-lease expense.

Kevin Campbell – Avondale Partners

Okay and then that, of course, gets partially offset by whatever new lease expense you take on with the new aircraft?

Aaron Todd

Correct.

Kevin Campbell – Avondale Partners

Could you talk about, lastly, on the G&A decline, I think it was down sequentially from $17.6 million to $15.9 million, and I didn’t hear any commentary on what drove that and maybe what might be a good estimate going forward for G&A.

Aaron Todd

As we mentioned in our last conference call, there was roughly a couple of million dollars in the first half of the year that was associated with higher training costs to retrain the CJ pilots. We also had reduction in personnel surrounding the integration of CJ. So, the majority of that is the completion, as we had mentioned on our last conference call, of the duplicate training activities and the related administrative positions that were needed to get through that process. So, that’s a large portion of it that has resulted in that reduction.

Kevin Campbell – Avondale Partners

So that’s roughly around the $16 million level is probably a good point to move forward from here at this point?

Aaron Todd

Yes. I mean, with $16 million, and it’s certainly not going to go up because we’re just not adding a lot of bases in this environment.

Kevin Campbell – Avondale Partners

Okay, alright. Thank you very much.

Operator

Our next question comes from the line of Greg Williams with Sidoti & company.

Greg Williams – Sidoti & Co.

Good afternoon, guys. Just a few quick questions.

Aaron Todd

Hi, Greg.

Greg Williams – Sidoti & Co.

Hi. I think I asked you the same question last quarter, and I just want to repeat it, did you guys perhaps see, due to the volume weakness, less volume due to maybe just anecdotally, I know it’s hard to quantify, but headline shock or all the accidents.

Aaron Todd

Yes, it’s a great question. It’s really hard to say. I mean, we’re not hearing anyone saying, “Hey, we’re calling you less just because of the recent spat of accidents within air medical operations.” It’s never a positive, and certainly there could be some added measure of caution in those patients that are borderline relative to where they can go be a ground or air, but our fluctuations, one, they were very, very abrupt, they started in June and kind of accelerated, and certainly there had been accidents before that.

But the other issue is, we’ve not seen that in the past. In ‘04 and ‘05, those were very challenging years with frequency of accidents, and we did not see softness emerge during those years, and more importantly, we’re also seeing our hospital customers see a reduction in ER admissions period. So, if they’re going via ground versus air, you would not expect our hospital customers to be reporting softness in ER admissions, which they are. So, those are our anecdotal evidence points that would suggest that that’s not having a material effect, but it’s certainly not having a positive effect. That’s for sure.

Greg Williams – Sidoti & Co.

Okay, those are good points. Thanks. Can you talk a little bit about the cost-saving efforts? Not just the twin to single-engine, but the base shutdown and the dispatch consolidation? Maybe the progress there, and are you still on track with those savings?

Aaron Todd

Yes, it’s a great point. If you’ve got two bases and one is doing 35 transports and the other is doing 35 transports a month, and let’s say you could shut one base down and have the surviving base doing 45 transports a month, with the other 25 going with a competitor or something else, you’re actually going to do a whole lot better relative to your contribution to earnings than you would if you just tried to continue to keep both open at a lower utilization level.

So, what we do is, we evaluate opportunities especially when a base is barely breaking even or on a fully-absorbed basis, losing money that we try to look for those contiguous opportunities to consolidate locations and lose the least amount of flight volume as a result of those consolidations. So, we’ve done, I think, four and a half like that year-to-date, and when I say a half, we’ve shifted one from 24 hours to 12 hours, and that can also help greatly in improving Same-Base Transports.

Greg Williams – Sidoti & Co.

Okay and the remaining, or the identifying eight twin to singles you said you would probably – or, I guess, when would you realize those, you said as soon as they come in, but can you maybe give us a little more color? A timeline on when you would expect them.

Aaron Todd

I don’t have the exact reference, but I think about half of those will be in the next three to five months. We’ve got to get them through completion, and then the rest will probably be second quarter next year kind of thing.

Greg Williams – Sidoti & Co.

Okay and I guess the last question I have is, you’re looking at possible price increases in January. I would assume around 5% increases again?

Aaron Todd

Well, we haven’t announced it. I think we’ll be pretty consistent with what we’ve done historically. We’ve been in that 6% to 7% range in each of the semi-annual adjustments to gross charge structure. Of course, we net a lesser percentage in our improvement in net revenue for transport outlook, but we’ll probably be in those ranges.

Greg Williams – Sidoti & Co.

Okay, thank you.

Aaron Todd

You bet.

Operator

Our next question comes from the line of Charles Griege, with Blue Lion Capital.

Charles Griege – Blue Lion Capital

Good afternoon guys, just a couple of cleanup questions. Your CBM transports in the quarter?

Aaron Todd

Just the total number?

Charles Griege – Blue Lion Capital

Yes.

Aaron Todd

The total number of transports for the quarter was on the pre-announcement, and I’ve got that here. Hold on. Let’s see if I can just find it, here it is. Well, here we go. You’ve got a calculator there, Charles?

Charles Griege – Blue Lion Capital

I do.

Aaron Todd

Take 3760, 3734 and 3196, and that’s the number.

Charles Griege – Blue Lion Capital

So 10690?

Aaron Todd

Thank you.

Charles Griege – Blue Lion Capital

Okay and you said aircraft rental in the quarter was $12.3 million?

Aaron Todd

That’s correct.

Charles Griege – Blue Lion Capital

And that’s versus…

Aaron Todd

Trent will have that for you in a moment.

Trent Carman

Versus the prior-year amount?

Charles Griege – Blue Lion Capital

$6.3 million last year?

Trent Carman

That’s correct.

Charles Griege – Blue Lion Capital

That really seems high, and I’m just…

Aaron Todd

Well, you’ve got to remember, we acquired CJ Systems which added 40% increase to our fleet, and almost the entire CJ fleet was leased. So that’s all acquisitions.

Charles Griege – Blue Lion Capital

Right, I’m comparing it to the prior two quarters, where it was a little over $11 million first quarter, and $11.7 million in the second quarter.

Aaron Todd

Well, Charles, remember, we are doing massive amounts of fleet rejuvenation where we are taking aircraft that have a lower ownership profile but a very, very high maintenance profile and we’re retiring those assets for new aircraft that have a higher lease expense but a much lower maintenance profile, and it’s in our favor to do that. We dramatically increase the utilization.

So, while it hasn’t certainly materialized in the last couple of quarters, certainly in 2007 we benefited greatly from this, and we will continue to benefit long term in replacing older model aircraft, which increases the ownership cost, but reduces the maintenance expense per flight hour.

Charles Griege – Blue Lion Capital

And as I look at it, your aircraft rental expense looks like it has gone up by 200 basis points. What is the expected savings on the maintenance line? And, I’m just trying to understand how accretive it is.

Aaron Todd

Well, you have to look at it on a per-aircraft basis. Typically, if you’re retiring an older-model twin, you could be looking at anywhere from $800 to $1000 a flight hour, versus $400 a flight hour on a new twin, and if you’re flying 500 hours a year with a $400 an hour savings, you could be saving $200,000 a year on maintenance, even though for an increase in valuation of, say, $3 million, you might be looking at something like $250,000 higher on ownership, but keep in mind, I’m also benefiting from warranty, and I’m also benefiting from a higher utilization level, where I might enjoy a 98% in-service rate on the newer aircraft, I can be as low as 82% in service rate on the older twin, which requires me to carry more backup in the fleet, and that added cost has to be included. So, it’s about a wash, but it certainly benefits us by having a higher availability rate.

Charles Griege – Blue Lion Capital

But, from just a dollars and cents standpoint, it doesn’t necessarily increase.

Aaron Todd

It’s not a massive windfall, no.

Charles Griege – Blue Lion Capital

Okay, I just wanted to clarify that and then just a couple of other questions. How many shares did you guys buy back?

Aaron Todd

It was 100,000 shares at roughly $29 a share. We’re pretty awful investors, aren’t we? But we still believe that it was a good valuation at that point, and we obviously believe it’s a greater valuation at this point.

Charles Griege – Blue Lion Capital

And then the fuel expense in the quarter and how that compared with the previous year?

Aaron Todd

Again it was up 56% year-over-year for the first nine months on a per-flight-hour basis.

Charles Griege – Blue Lion Capital

I was just trying to think about it on a quarterly basis.

Aaron Todd

Well, I didn’t break it down by quarter, but you’ve got $13.6 million in total fuel expense for the year. I don’t think I’ve got the fuel number for the quarter right in front of me.

Trent Carman

It would be about $5 million to about $5.2 million, somewhere in there.

Aaron Todd

It would be around $5 million, so if you’re up 56% it would be a couple million. I think the press release mentioned what the impact was for fuel.

Trent Carman

It didn’t say the gross dollar amount, though.

Charles Griege – Blue Lion Capital

Yes, it was up per hour flown, but we don’t know what the hours flown were, so I’m just trying to figure out the best way to model this.

Aaron Todd

Hold on a second. No, it says in addition fuel expense – oh yes, I do have that number. It’s – $1.8 million was the impact of the 58%.

Trent Carman

For just the quarter.

Aaron Todd

For the quarter. It was – it’s under the segment “Information or Community-Based Services.”

Charles Griege – Blue Lion Capital

Okay. So it was $1.8 million delta?

Aaron Todd

Correct.

Charles Griege – Blue Lion Capital

And, given the free cash.

Aaron Todd

Delta, that’s the increase attributed to the higher cost per gallon.

Charles Griege – Blue Lion Capital

Right and, given the significant cash flow you generated, what’s the balance between share repurchases and debt? How do you think about that, particularly with your stock down here?

Aaron Todd

Well, it depends on what the share price is and how the free cash flow comes in. We’ve got a certain amount of the debt retirement that is scheduled. We’ve probably got $7 million to $8 million in a given year that have to retired anyway, so that’s going to happen automatically and then the rest, it would be at our discretion.

Charles Griege – Blue Lion Capital

But beyond that kind of minimum, particularly with your stock down here?

Aaron Todd

Well, Charles, are you asking me how much shares I’m going to buy back in the next three months?

Charles Griege – Blue Lion Capital

No, I’m not. I’m just trying to understand how you guys think about it.

Aaron Todd

Well, we think about it in a lot of ways. We think about it in terms of making sure we have adequate cash to fund operations and new acquisition opportunities, as well as making sure that we look at where we are relative to our covenants. We try to make sure that we at least $50 million of immediate accessibility within our covenant profile for cash access, and then we deal with the excess, and the bias would be towards buyback anything above that.

Charles Griege – Blue Lion Capital

I’m sorry, you mentioned that earlier, what’s your availability today?

Aaron Todd

The availability is $31 million, but there’s $20 million in pending financing that will be closed within the next couple of weeks that will bring us to about $50 million, and then we’ve got the $7 million receivable that will be liquidated in the next 20 days with FEMA, so that would put us in about a $57 million surplus, but, again, that doesn’t mean that that’s my borrowing capacity under the – I have another $50 million of unencumbered aircraft that I could tap into if we wanted to leverage those to retire shares.

Charles Griege – Blue Lion Capital

Okay. Well, I’ll get back in queue. I may have a few others. Thank you.

Aaron Todd

You bet.

Operator

Our next question comes from the line of David Bachman with Longbow Research.

David Bachman – Longbow Research

Hi, good afternoon guys, just a couple of questions here that you haven’t covered already. You mentioned the perhaps 50% to 60% transports directly or indirectly related to road travel. I suppose it would be sort of more trauma, how do I think about sort of the medical breakdown of the rest of your transports?

Aaron Todd

Well, we do everything from neo-natal transports to pediatrics to heart victims, burn victims, basically anything that has a high degree of acuity but may not be associated with a trauma event.

David Bachman – Longbow Research

Okay and, in terms of shifting medical protocols around, though, as you’re feeling – you kind of touched on it earlier, but I’m not really sensing that there has been a shift there that might be having an impact.

Aaron Todd

Well, I think the Maryland State Police accident brought to surface in greater degree the question of medical necessity. It’s an unfair comparative because Maryland State Police do not bill patients, and therefore do not have to follow a predefined protocol to determine medical necessity in order to ensure, the ability to bill for that transport, because Air Methods community-based operations are all accredited, there is defined processes we have to go through to ensure that we are doing appropriate transport.

So, I think more than the accidents being the accidents are indirectly related to the debate, but I’m not saying that it is not having an impact, but we’re not aware that it’s having an impact in any specific way.

David Bachman – Longbow Research

Okay, that’s helpful and then on the CBS side, you touched on consolidation of bases earlier. I mean, are there any geographies where perhaps for competitive reasons you sort of intentionally, I guess, have extra capacity? Maybe a couple of bases to – that just made since competitively in those markets?

Aaron Todd

Well, sure. There’s always locations where maybe we would prefer to only have three locations in that market but we have five because we know that if we shut down two our competition will be made more viable in that market and begin to encroach upon our other locations.

So, sure, I mean there are markets where we are in a defensive posture. We do not have any locations where we operate at a loss on a direct-cost basis, and if we do, obviously, we’re not going to bleed in a specific location just to maintain a competitive posture, and so the answer to your question is, sometimes we will attempt to consolidate those, depending on where the volumes are, but if I had no competition in the United States, I could probably reduce the number of bases by 30 or 40 and still be able to complete and still have adequate service.

Keep in mind that an air medical helicopter can do anywhere from 70 to 100 transports per month. Our average bases are doing in the upper-30s per month and so we’re probably only at 40%, 50% of capacity and a large reason for that is one, making sure that we’re in close proximity of where the patients are needing service, but also the competitive environment where we operate.

David Bachman – Longbow Research

Okay, that’s helpful color and then one last question, on the hospital base side, this kind of economic climate, are hospitals more – hospitals are currently running their own operations; any pressure on them to look at other arrangements?

Aaron Todd

Sure, yes, absolutely. I mean, these costs are getting any cheaper. Certainly, as we know, they’re experiencing softness in demand as well, and for some of them who are – who before we were operating on a break-even profile maybe now we are in a subsidized mode for non-core services, many of them are evaluating outsourcing possibilities, but we’re happy to be their service provider indefinitely if they choose to stay in the business, and we’re happy to try to partner with them should they choose to outsource.

David Bachman – Longbow Research

Okay, that’s great. Thanks.

Aaron Todd

You bet.

Operator

And we do have a follow-up question from the line of Charles Griege with Blue Lion Capital.

Charles Griege – Blue Lion Capital

Yes, a couple of follow-ups. First, maintenance expense in the quarter and in the year-ago quarter, if you have that number?

Trent Carman

Maintenance by itself.

Aaron Todd

Hold on. Unfortunately, we’re not in the office so we could give that to you Charles, and we will be happy to break that out for you, because it’s embedded in aircraft operations, but, wait, hold on, I can get you close. Just give me a second. We’re away from the office I’m going to have to get back to you on that, but we would be happy to provide the number.

Charles Griege – Blue Lion Capital

Okay, just the follow-up question, you’re generating a lot of cash. From the looks of it, particularly given Same-Base Transport, the inability to have positive cops, so to speak, you may have some excess bases and for defensive reasons you may or may not want to close them, but there doesn’t seem to be a reason to be growing your bases here. Is that a safe assumption?

Aaron Todd

Well, keep in mind, our hospital-based operations, we’ve added nine new bases relative to satellite expansion under those contractual relationships. So there is still a lot of growth there.

Charles Griege – Blue Lion Capital

But those aren’t really consumers of capital, right?

Aaron Todd

We have closed down our rate of expansion. I think we have only added two or three bases this year, and we’ve shut down four and a half, but we added a whole lot the year before, and we’re still kind of digesting some of that growth. So, I’m not saying that I, again, we’ve been pretty clear on this. We believe that about two-thirds of our base expansion we would expect to be assumption of operations as hospitals choose to outsource these services, but our intent is not to just go continue to add aircraft in green field locations in this environment.

Charles Griege – Blue Lion Capital

And the cost to take on a hospital base is far less from a capital standpoint?

Aaron Todd

Well, actually there’s no difference. They’re actually the same. You still need an aircraft to operate. The difference is, is that you’re not adding capacity to the marketplace, and you tend to be operating in locations that already have a lot of history and maturity in those markets that tend to lend itself to better utilization.

Charles Griege – Blue Lion Capital

Right, but in terms of out-of-pocket cost for Air Methods? Minimal, correct?

Aaron Todd

Well, it costs us about $150,000 in startup expenses to start a brand-new community-based location. If we are already providing the service to a hospital and they choose to outsource the service fully to us, then, of course, we wouldn’t have that $150,000. So, the difference is only about $150,000 per base.

Trent Carman

What you would have, though, Charles, is you would have a build in your accounts receivable. Right now you don’t have much day sales outstanding from a hospital contract, but you have, as we mentioned, over 100 days of receivable build for a community base. So, it would be a working capital usage but not any other source of capital.

Charles Griege – Blue Lion Capital

Right, I mean you didn’t like the way I asked the question the last time, so I’ll try and ask it a little differently. You’ve got a $50 million line or availability that you want to preserve, day-in, day-out to run your business. It sounds like $50 million worth of equity in your aircraft outside of the equity in your leased aircraft; you generate a lot of cash. In the current environment, doesn’t it make more sense to buy your stock back outside of the amortized principal payments you’re required to make? Certainly confine another competitor in here.

Aaron Todd

Yes, but keep in mind, I’ve got to look forward, let’s say for sake of argument that I see a 10% reduction in Same-Base Transports over the next couple of quarters. I’ve got to look at, okay, where would my EBITDA profile be there? What kind of coverage ratio would I have and if I borrowed against the line or against the unencumbered aircraft, would I still have $50 million of availability to ensure that I could continue to operate safely relative to cash flow?

So, we have to factor the downside risks as well, and so we would keep some cushion there, but, yes, I think it probably is pretty attractive at these prices to buy us towards buyback rather than arbitrary reduction rather than discretionary reductions in the line.

Charles Griege – Blue Lion Capital

And I guess my last question would be on your fuel cost side. Have you given any consideration, and is it even possible to hedge some of your fuel cost? What’s happened here?

Aaron Todd

Yes, that’s a great question, and we were thinking we might want to hedge at $100 a barrel. We’re really glad we didn’t, so we were literally looking for an opportunity to maybe hedge some of our fuel, but fuel has never stopped declining long enough to consider it a good time to do it. What we’ve talked about doing is maybe putting in a hedge where maybe if it’s below $40 a barrel, we don’t participate in that. If it goes above $80, $90 a barrel, then we have protection.

I don’t think we’re going to do a narrow collar around the current price, but I do think that we may buy some insurance from it ever going back up into the $90 plus range, but in order to not have to incur added cost to do that, we may have to give up some of our upside by not participating below $40. We’re looking into that kind of structure right now. It’s already set to go. We already have our relationships in place. We’ve just been waiting for the right time to do it.

Charles Griege – Blue Lion Capital

Thanks, and I’ll follow up with Trent on the.

Aaron Todd

Yes, I apologize, we just completed a board meeting, and we’re here in San Antonio and we just don’t have our internal statements with us.

Charles Griege – Blue Lion Capital

Well, if you come through Dallas, stop by.

Aaron Todd

Will do.

Operator

At this time, I’m showing that there are no further questions.

Aaron Todd

Okay, well we appreciate your participation today. Trent and I are always available to answer your questions. The 10Q should be out, I believe, tomorrow, and will be available all day tomorrow to answer any additional questions you have, and, again, thank you for your participation today.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: Air Methods Corporation Q3 2008 Earnings Call Transcript
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