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Executives

Joe Dorame - IR, Lytham Partners, LLC

Aaron Todd - CEO

Trent Carman - CFO

Analysts

Bob Labick - CJS Securities

Kevin Campbell - Avondale Partners

Greg Williams - Sidoti & Company

Matt Delefona - Blue Street Capital

Air Methods Corporation (AIRM) Q4 2007 Earnings Call March 12, 2008 4:15 PM ET

Operator

Good afternoon. My name is Amanda, and I will be your conference operator today. At this time, I would like to welcome everyone to the Air Methods fourth quarter 2007 financial results conference call. (Operator Instructions)

Mr. Dorame, you may begin your conference.

Joe Dorame

Good afternoon. Thank you for joining us today to review Air Methods financial results for the fourth quarter and year end 2007, ended December 31, 2007. As Amanda indicated, my name is Joe Dorame. I'm with Lytham Partners; and we are the Financial Relations Consulting Firm for Air Methods. 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 Q&A session.

I would like to remind everyone this conference call contains forward-looking statements within the meanings of the Private Securities Litigation Reform Act of 1995. Forward-looking statements 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 operations, the size, structure, and growth of the company's air medical services and product to markets, the collection rates 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'd like to turn the call over to Mr. Aaron Todd, Chief Executive Officer of Air Methods. Aaron?

Aaron Todd

Thanks, Joe, and thanks to everyone who is joining us on the call today. We're obviously pleased to have completed our third consecutive year of strong growth in both top and bottom line performance. Our fourth quarter results represent the first full quarter of combined operations since our acquisition of CJ, and reflects strong growth in quarter-over-quarter earnings despite the severity of weather in the final quarter of 2007.

Although Trent will discuss in detail our 2007 financial results, I wanted to highlight one significant point. The company generated over $27 million in cash flow from operating activities during 2007, this is despite overpayment of estimated income tax during the year. We are presently anticipating a significant refund in excess of $20 million for overpayment of estimated income taxes during 2007. This overpayment status was triggered by certain deductions resulting from the acquisition of CJ, recent IRS approval of changes in tax depreciation methods and current year update to the three year average tax deduction rate for estimated uncollectible receivables. This refund will not impact income tax expense.

Our long term debt, net of cash in this short term income tax receivable was $67 million as of December 31st, 2007 or approximately one times our 2007 EBITDA. We anticipate the refund being received during the second quarter of 2008.

By way of update on key measures and other factors, since our last conference call, I offer the following. The integration of CJ is going extremely well. Excluding the one CJ customer, which we announced in our previous conference call, would not be renewing their contract with us, only one additional customer has chosen another service provider to-date.

As of the end of February, we have reduced a net 30 full time equivalent administrative support positions through the consolidation process. The consolidation of the two FAA operating certificates into one is expected to be completed by June. We have also been able to consolidate one of CJ's hospital based programs into our existing community based operations, thus helping us to generate significant cost reductions.

The recent reduction in interest rates has also reduced the carrying cost of the acquisition financing; Trent will quantify this for you in a moment.

Based on the contribution of CJ's operations to our net earnings during the fourth quarter, we are on pace to achieve our beginning objective of 10% to 20% accretion in EPS during the first full year of combined operations.

We continue to maintain our year-over-year improvement in day-sales-outstanding in our community-based receivables. As of December 31st, 2007, our DSOs were 108 days, as compared with 133 days as of the end of 2006. This number is computed utilizing annualized three month sales. DSOs as of September 30th, 2007 were 107 days. During the year 2007, we added 35 aircraft to our fleet, excluding those acquired in the CJ acquisition. Of these 35 aircraft, 23 were deployed as additions to the fleet and remaining 12 were in replacement of aircraft sold or otherwise removed or disposed off.

During the year 2007, we added 13 new community-based locations and ceased operations in one location, excluding those locations added as a result of the CJ acquisition. Within our hospital-based operations, we added contracts for seven new locations and did not renew contracts covering four locations, excluding those acquired from CJ. The contracts that were not renewed transferred to another provider during the first quarter of 2008.

We also added a new satellite location during our first quarter of 2008 within existing hospital-based customer. Excluding the impact of increased weather cancellations and excluding the impact of cannibalization from new adjacent bases added to our operations, same-base transports would have increased by 1.6% for 2007.

Effective January 1st, 2008, we increased our gross charges for community-based services by an average 6%. We anticipate placing 38 new aircrafts into service in 2008. The majority of these new aircrafts will be used to replace older model aircrafts, and this will continue to have a moderating influence on our hourly cost for maintenance.

As you know, our recurring annual objective is to grow earnings by greater than 20% each year. This objective presumes normal weather patterns, consistent reimbursement rates, and on-budget performance for maintenance expenditures. While the more extreme weather patterns during the first quarter today, that have adversely impacted our flight volume; we would anticipate that we will be able to achieve our objectives in 2008, subject to more moderate weather the rest of the year and on target performance in other key variables just mentioned.

With that, I will turn the call over to Trent to discuss the fourth quarter results in greater detail.

Trent Carman

Thank you, Aaron. As we reported in today's press release, revenue, net income and earnings per share for the fourth quarter 2007 were $122.6 million, $4.8 million and $0.38 per share respectively. This compares to revenue, net income and earnings per share of $77.5 million, $1.2 million and $0.10 per share respectively for the fourth quarter of 2006.

During the fourth quarter, revenue generated by our community-based services division grew $20.5 million or 41%. The acquisition of CJ Systems on October 1, 2007 contributed $11.1 million to this increase. The remaining increase in CBS revenue related to increased flight volumes from newly opened bases and to increase in our net revenue per transport.

During the fourth quarter, revenue generated by our hospital-based services division grew $22 million or 83%. The acquisition of CJ Systems contributed $19.3 million to this increase. The remaining increase in HBS revenue related primarily to price increases. Using the fourth quarter of 2006 cost of fuel per transport, fuel expense for the fourth quarter of 2007 was approximately $700,000 higher than during the fourth quarter of 2006.

General and Administrative expenses were $15.7 million and $10.5 million for the fourth quarters of 2007 and 2006, respectively. The fourth quarter of 2007 includes $227,000 of incremental expense associated with the expensing of stock options. The majority of the remaining increase relates to additional staffing related to the CJ Systems acquisition.

General and Administrative expenses were 12.8% and 13.6% of revenue for the fourth quarters of 2007 and 2006, respectively. Earnings before interest income taxes depreciation and amortization or EBITDA were $13.4 million and $8.6 million for the fourth quarters of 2007 and 2006, respectively.

For the years ended 2007 and 2006, EBITDA was $65.6 million and $48.8 million, respectively. You can reconcile EBITDA by adding interest expense, depreciation and amortization, loss on the extinguishments of debt and subtracting the gain on disposition of assets to income before income tax expense.

Operating income before the loss on disposition of assets as a percentage of revenue was 7.1% and 6.3% for the fourth quarters of 2007 and 2006, respectively. Income tax expense for the fourth quarter was reduced by $1.1 million for the affect of changes to depreciation expense taken in prior year's income tax returns.

Our current asset position, current assets less current liabilities, was $112.8 million, at December 31, 2007 as compared to $92 million at December 31, 2006. part of the increase in our current assets relates to incremental -- accounts receivables acquired with CJ acquisition and to $15.8 million of increased refundable income taxes.

The company's net current debt position which is the total of all debt less cash was $90 million, at December 31, 2007. This compares to $68.1 million at December 31, 2006. Exclusive of the debt related to the CJ Systems acquisition, debt decreased $14.3 million during 2007.

As of December 31, 2007, the company had approximately $32 million in excess availability under its revolving line of credit. The company has benefited from the recent Fed interest rate reductions. Since the third quarter of 2007, the effective rate on our floating rate bank credit facility has increased by approximately 240 basis points. At December 31, 2007, we had $66.6 million of floating rate debt under that facility.

As of December 31, 2007, our products division was under contract for the production of 10 HA 60L units, 50 MEV units and three commercial interiors. The backlog of revenue for these contracts is estimated to be $7.4 million. As of December 31, 2007 the company had a total of 341 aircraft in its fleet, of these 203 aircraft were in the hospital based service division and 138 were within our community based services division.

The company currently operates 106 community bases and 157 hospital bases. With that, I will turn it over to Aaron for his closing remarks.

Aaron Todd

Thanks Trent. One of the things that I failed to highlight is we have seen a dramatic increase in our backlog within the products division, we look for a very good year out of that division as well in 2008 and it is one of real up trends as well as the other things we've discussed so.

With that final little highlight, we'll go ahead and open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Bob Labick with CJS Securities.

Bob Labick - CJS Securities

Good afternoon, congratulations on a good quarter and year.

Aaron Todd

Thanks Bob.

Bob Labick - CJS Securities

Hi, first question is, I want to verify if I heard you correctly. You said the price increases for the CBS division of 6% on January 1?

Aaron Todd

Yes.

Bob Labick - CJS Securities

Okay, great. And I assume all of the CJ bases are also brought up to the same level, obviously, its probably more than 6%, but they were brought up to the same level as all of the…

Aaron Todd

Yeah, basically the growth charge structure would be consistent, there would be no difference. We have differences depending on what part of the country, but there would be no differences from an Air Methods Community base versus a CJ Community base.

Bob Labick - CJS Securities

Okay, great. Can you just speak to the effectiveness of last year's price increases, I guess, certainly, you probably have data on the January 1 of last year, I don’t know if you do on the July 1?

Aaron Todd

Yeah, it's still a little early on July 1. We look at it and there is always a smidgen of increase in pushback with any new price increase, but it was in the 1%, 2% range. It wasn’t anything material as far as the collection rate that we were getting as a percentage of growth charges from the hospital, I mean from the insurance companies.

And so there is nothing -- as you have seen with the quarterly disclosure, our reimbursement rate has been holding fairly steady and has been reflecting a modest percentage of those increases. It's important for everyone to note that a 6% increase in gross charges translates into a 3%, 4% increase in your net reimbursement for transport. Because you are not going to collect anymore from Medicare, Medicaid and probably very little more from uninsured with the exception of annual inflators that occur typically on January 1 for Medicare and Medicaid.

Bob Labick - CJS Securities

Okay. Great. And then just in terms of your industry outlook, I was wondering if you could give us -- you know, I am asking these questions because I have gone through all the numbers in full detail, yet some more broad questions. Give us an update on the competitive landscape particularly as it relates to Air Evac, if there is anything new there or then if not we are just probably speaking about the industry outlook penetration of CBS bases and growth potential for CBS or Air Method over the next few years, in terms of bases and opportunity there.

Aaron Todd

Well, I think it's -- I don’t think there has been a lot of change since we were speaking on the last conference call. Air Method's beginning in really '07, the bases that it has added, it's tried to wait about two-thirds of the base additions to taking over mature existing programs or operations. Whether that's through hospitals or outsourcing or you know the consolidation of certain markets. We believe that, that's the right model going forward. The year before in '06, I think we kind of had the reverse of that. We had about two-thirds of our new bases that were, if you will Greenfield expansions. And so we believe that, that's the right way to grow, that you don’t get a dilution of your average patient transport per base per month.

Relative to the broader market, we believe that '05 was probably the high water mark as far as new numbers of aircraft added. It was in the 100 range. I think the US fleet grew by about 14%. We have seen that come back into the 60ish range in '06 and that's probably about where it was in '07.

So, you are still seeing expansion. But again I think sometimes that's misleading because growth doesn't need to come nearly by adding the number of bases operating within the country. It can be driven by the assumption of operations that were previously operated under the umbrella of a hospital or a hospital consortium. And they were continuing to see good appetite from hospitals in considering risk sharing or full outsource models.

We don't push that. We are happy to be their vendor for as long as they would like to stand with that model, but more and more are seeing the benefits of an outsourced arrangement and we are more than happy to support them, if that's their desire.

Specific to air-vac, as some may know there was a raid on their operation back in May around questions over their billing practices. We have not heard anything definitive or even frankly credible on a rumor side as to where that might all end up, but it has been very, very quite. They continue to operate as business as usual. So, just not a whole lot of news to report there.

Bob Labick - CJS Securities

Got it. So you measure after and that made me think. We obviously saw the release, but could you elaborate on the announcement of Paul Tate as the COO? And what his role will be, and how that will impact you, get used to more time, take away the COO role from you and leave here CEO?

Aaron Todd

Yeah. Great. Thanks for asking the question. I probably should have addressed it in my opening remarks. We are very pleased that Paul Tate has agreed to join us in management. Of course, he is resigning from his Board seat in order to facilitate the transition.

In the aftermath of the CJ acquisition, the demand on my time away from headquarters had increased quite a bit. We almost doubled the number of our hospital customer relationships. We want to make sure that they feel and indeed do have full access to the CEO of this corporation.

And so I was spending a lot more time in developing those relationships and certainly just the greater scope of our operation is creating more opportunities for business development for possible M&A consolidation opportunities. And so in order to ensure that the operations and the focus on, shall we say, the cost side of what we do.

We felt that Paul Tate would be just absolutely fantastic to be able to come in and ensure that we are staying lean and mean that we are realizing the efficiencies are now available because of the CJ transaction and helping us to drill deep into the organization to find those savings that are probably there.

And so it in no way reflects my commitment to this company while it does give the company a greater depth at the top. I am fully committed to Air Methods and have no intentions of departing any time soon so long as the Board is in accordance with that objective of mine.

So he will be on board, March 31st and will be focused mostly on internal operations and then ensuring there that we are maximizing efficiency opportunities.

Bob Labick - CJS Securities

Great. I'll get back in queue and let others ask. Thank you very much.

Aaron Todd

Thank you.

Operator

Your next question comes from Kevin Campbell with Avondale Partners.

Kevin Campbell - Avondale Partners

Thanks for taking my question. I wanted to start-off by asking a question about your products division actually. You had mentioned you expected it to be a good year in 2008, and I think you said you had backlog of a little over $7 million. How long does it take you to work through that backlog? Does that mean we should expect about $7 million in revenues in the first quarter, or is that six months to get through? Can you give us some idea as to --?

Aaron Todd

No, they did about $9 million in revenue, and just give me a moment. They are projecting the beginning of the year outlook is going to be in the low-teens, I mean it's $13.3 million, so a $4 million increase. But keep in mind, they tend to operate with higher margins and that can certainly be if they perform to expectation, have a meaningful impact on the earnings per share profile for the company.

Kevin Campbell - Avondale Partners

Could you talk to about, I know you briefly touched on the integration, and when you first made the acquisition you talked about lower insurance and consolidation of bases and improving the reimbursement and also I think the administrative functions and the re-pricing of the hospital-based contracts. Are there any of those four or five things that are maybe going better than you expected? And if so, can you elaborate it? And perhaps are there any that are going worse?

Aaron Todd

Well, some of this is just a confirmation of what we disclosed in November. They did go to our lower insurance rates effective October 1, so that occurred exactly as expected. We had three redundant locations. What we have done is, I guess you could say we've accomplished that, but in reality we shut down one. We're shifting another one to a traditional hospital model and the other one has just been relocated.

So I think you could say that we're essentially through that process. We had the loss of the two contracts that did not renew. There were not a lot of earnings that were being generated from the traditional hospital contracts, but there is always some contribution there, but that has probably been more than offset by the conversion of the traditional hospital program into a consolidation within one of our markets under the community-based model. So I think you could look at those as a wash. The FTE reductions are pretty much on track.

Looking at the net reimbursement profile that we had expected from the CJ operations, it's almost right on target, it's almost exactly equal to what we thought it would be. And those were some of the key drivers. The long-term upside is certainly going to depend on our ability to solidify these relationships, stay competitive in the marketplace, but hopefully be able to get some margin improvement as these contracts renewal over time.

Kevin Campbell - Avondale Partners

Okay. Thanks. That's helpful. Could you talk then too about the G&A. I know I think maybe came in at $15.7 million or so. Should we expect that perhaps to trend down with some of the cuts that you made or maybe will be making going forward? Or is that a good run rate that we should maybe assume?

Aaron Todd

It's always hard to trend that line, because as you know you've got a much higher G&A number when you're expanding community-based operations, your billing department, your dispatch, all of your program administration is in there. I think the better one to really look at is corporate administration within the segment footnote and that's always been a fairly well healed number if you want it for the comparatives of the year. It was basically $9.4 million for 2006, is about $13 million for 2007. And the majority of that increase had to do with certain option grants that were given to Senior Management and the Board, that were expensed.

So, when you subtract that out, it's a stronger indicator of the ability to contain cost. But on the divisional G&A that's probably going to track fairly closely with revenue growth and with a constant profile on the percentage side. I think the one exception to that is, we still have some FT reduction that's going to occur as we consolidate the FAA certificates and we will pickup a few more there. I think the aggregate number that we are projecting within that 40 range, and we're about three quarters of the way there. So, I would say we're fairly on track there. But I wouldn't project a huge reduction in percentage profile there.

Kevin Campbell - Avondale

Okay. Thank you. I will jump back in the queue.

Operator

(Operator Instructions)

Your next question comes from Greg Williams with Sidoti & Company.

Greg Williams - Sidoti & Company

Good evening gentlemen, thanks for taking my call. Trent, I'm just trying to get from GAAP EPS to some pro forma here, you mentioned in the press release $0.08 in lower taxes for prior year recognition of tax depreciation. Is that correct? Is that all recognized in the fourth quarter then?

Trent Carman

That's correct.

Greg Williams - Sidoti & Company

Okay. And that's offset by $0.04 here in [just division] of assets?

Trent Carman

That's correct.

Greg Williams - Sidoti & Company

Okay. So what can we expect going forward for a tax rate?

Trent Carman

You are still in that 41% to 42% range, so the difference, I mean that's what we're running at currently.

Greg Williams - Sidoti & Company

Okay. And then as far as base expansion, I think, Aaron you alluded to it maybe slowing down a little bit. You have 106 bases today; I think you have mentioned maybe eight new bases in the year, is that still on track?

Aaron Todd

I would say that we are going to be in that six to eight range, we are not going to be in that net 12 range.

Greg Williams - Sidoti & Company

Okay.

Aaron Todd

I mean we could if that was really the objective. But, we are really focusing heavily in 2008 on increasing same base transports. You might have noticed, which was very encouraging to me, that despite the fact that we had 500 -- increase in weather cancellations by 500 during the months of January and February in 2008, we only had a reduction in same-base transports by a little over 200. That would indicate that the efforts to really try to improve utilization at existing bases are starting to pay off. We can't get Mother Nature to be a little less ferocious; hopefully that growth rate will start to materialize.

We are not going to see the cannibalization affect, as we mature the bases added in '07, beyond the one year mark. And as anyone who runs these numbers know that the amount of margin enhancement that can be generated by improved utilization is fairly dramatic versus just increasing bases. But at this time in year, last year I probably would have said the same thing and yet we did end up with quite of few expansions, because the outsourcing activities are fairly unpredictable, but I'm guessing we'll probably be in that six to eight range.

Greg Williams - Sidoti & Company

Okay. And a lot of that coming again from mature ops versus greenfield just --

Aaron Todd

Again, we would want that to be about a two-thirds ratio.

Greg Williams - Sidoti & Company

Okay. And just may be getting a benchmark, how many hospitals outsourced in the last 12 months?

Aaron Todd

Well, we have the one that emerged out of the acquisition, it was in that, and we had one due to consolidated in Florida and Columbia that's one, two, three, four, five, I think six.

Greg Williams - Sidoti & Company

Okay. So, sort of the same run rate going forward?

Trent Carman

Yeah.

Greg Williams - Sidoti & Company

Okay. And Trent just noticed, its in the cash flow statement, but looks like you used $5 million in cash quarter-over-quarter, maybe you can tell me what the cash from operations was, I am just trying to find out where the source or the use was rather?

Trent Carman

Cash flow from operations was $27.1 million.

Aaron Todd

We don't have it broken out for the quarter.

Trent Carman

No.

Aaron Todd

But the again...

Trent Carman

It would have been the tax. There was a tax payment during the fourth quarter that would be the change.

Greg Williams - Sidoti & Company

Got you.

Aaron Todd

And that's all coming back in. You will see when the 10-K comes out hopefully on Friday. You'll see a separate line item that shows income-tax receivable of $20 million, that compares to only a few million the year before. And so, when you add that back in you are going to get a fairly extremely attractive cash flow profile from operations, once that shows up in the second quarter.

Greg Williams - Sidoti & Company

Okay, great. And I think you also mentioned in script in hospital-base you lost four contracts, you did not renew four contracts, maybe comment on that? Did you pursue them avidly or what was going on there?

Aaron Todd

When we announced in November, and that was because we were a competitor with a traditional hospital customer of CJ and despite an attempt to try to, if you will, create a consolidation structure where we are not competing against one of our customers, we just weren’t able to get that done and we announced that last November. There was another customer in the Midwest where they own their own aircraft; there was a strong desire in the part of the customer to really have a lot of control over the operation. And we felt it best for them to go get their own Part 135 operation, and they joined with another hospital-base Part 135 operation. So, that they would have the ability to have more say control over the way they operated their program. So that was very amicable on both sides.

The two Air Methods customers that did not renew, one was here in Colorado and they were staunch competitors with our Air Life of Denver customer. We tried to bring reconciliation there and facilitate. Both wanted to expand into Northern Colorado, and when all was said and done the ability for both of them to do that with a common service provider became very challenging. So the contract did not renew mostly because of that. And we went ahead and did expand in Northern Colorado with the Air Life of Denver customer in the first quarter.

So essentially we did not renew a contract that had one ship and we stayed with our customer, they had multiple ships under contract. And added another ship to it, in essentially nearly the same location. So, that's pretty much awash. In Bend, Oregon that really came down to, that was a customer-owned aircraft environment. We had a competitor that offered incredibly attractive pricing to them, and while we tried to be as responsive as we could be, just in that field that we could go to that level. It was a very price sensitive customer and I felt that we would be better off not renewing at what to us would have been essentially a breakeven proposition.

Greg Williams - Sidoti & Company

Okay, great. Thanks for the details, appreciate it. No further questions.

Operator

(Operator Instructions)

Your next question comes from Matt [Delefona] with Blue Street Capital.

Matt Delefona - Blue Street Capital

Hey, guys, congratulations on the quarter.

Aaron Todd

Thanks.

Matt Delefona - Blue Street Capital

I was wondering could you break out for us a little bit, your growth ex the CJ acquisition on the EBIT line or EBITDA or earnings per share, however you feel comfortable I just wanted to…?

Aaron Todd

It's very difficult to do because as we've already mentioned, we've already begun to assimilate their operations into ours. G&A is almost all -- began consolidation day one. We had the combination of the traditional hospital-based operation into our community-based operation. So it's fairly extremely hard to do.

I will tell you just to be fair about it, that Trent, and I, attempted to do it, and did give it our best guess. And it came into that roughly as far as accretiveness to EPS for the fourth quarter, it was in that 25% range. So it was certainly above the 10% to 20% that we had given. But again, that is not something that you're going to see broken out in a SEC filing because, it's really a back of the napkin.

Now we did disclose in the press release -- in the SEC filing that our growth rate in revenue in the fourth quarter would have been 19%. In fact I think we had that on the press release.

Matt Delefona - Blue Street Capital

It's in the press release, I just opened it I see that on the bottom-line.

Aaron Todd

Yeah, and you know what, its going to be increasingly more difficult to do that. We are literally consolidating community based programs, I mean, using common -- I mean, the main reason for doing this was to truly drive a lot of efficiency within our operations and the ability to give a standalone number is going to become increasingly more difficult.

Matt Delefona - Blue Street Capital

Okay, that's fair enough, but do you think it's at least at the level?

Aaron Todd

It was a little over 20% when we had to estimate corporate G&A and SG&A by kind of looking at the third quarter and seeing out that it increased in the fourth quarter, and attributing the majority of that to the acquisition. I mean, it was that crude but when we did that, it still showed that we were north of 20%. Now, I caution everyone to take that as an extrapolation number because one quarter can merely be enhanced because of favorable maintenance or other factors so I would be careful. I think 10% to 20% is still the range I would use.

Matt Delefona - Blue Street Capital

Well, that's great. Thank you. Can you talk us through a little bit. I'm going to ask this question in one question but specifically two parts. One is in terms of acquisition environment in general and that both are in terms of what's available? Where are your customers, in terms of, I mean, everything from financing to availability of aircrafts, in terms of being able to be in a position where they are going to either want to be bought or need to be bought?

And then the second piece of that is also, as I think of the acquisitions portion. It is a little hard to differentiate when you brought over contracts from hospitals that are outsourced and sort of add them as full service bases. How are both -- you've talked about it but sort of, maybe, walk us through a little bit more specifically what the environment is for both of those and what the catalysts will be both for buying a competitor for example as well as for why a hospital will be outsourcing and if it is a cost issue why would you want to buy it, if it is costing you a bit more?

Aaron Todd

That’s the longest question of the month but I think I understand what you are asking. The -- about half of the US fleet, which we estimate to be about 850 aircraft operate under the traditional Hospital-Based model. And every year there is a percentage of those that choose to outsource and there is opportunity to assume operations under the Community-Based model.

Now we are obviously -- we have to be extremely careful that in no way do we become an influencer on that, because we do not want to alienate, our very precious and valuable hospital customers who have desires to stay in the business for the indefinite future and we want to retain that business as well.

So we are merely responding to opportunities that come to us to accomplish outsourcing needs as they arise. And at any point in time, Matt we are probably looking at half a dozen to 10 of our customers or other customers of competitors that have contacted us to talk about those types of scenarios. Some happen and sometimes the ones aren't talking to you call up on a Friday and say we'd like to do it on Monday, so that is really what I consider to be organic activity.

On the M&A side, our door is always open both to local, regional and national operators or Hospital-Based systems that are looking to divest fully and there is always activity going on there. Sometimes it involves a single market, sometimes it involves a region. Sometimes it could certainly involve another national operation like CJ. So, we will remain very active and open. The ability to finance helicopters is -- I would say extremely irrelevant to that environment. There is still -- helicopters are a wonderful value retaining asset. They've got a very, very powerful marketplace right now and the asset based financiers are very -- have a great appetite to continue to fund this paper and these acquisitions. So, I don’t think anyone is saying, gee, we need to get out of the business because we are not able to finance new helicopters. I think if you have got a good solid cash flowing business, you should be able to get the helicopters financed even in this stressed market.

Matt Delefona - Blue Street Capital

Perfectly understood. I was actually -- helicopter financing made sense I was thinking more in terms some of your competitors that are owned by private equity firms?

Aaron Todd

Oh sure. Well yeah…

Matt Delefona - Blue Street Capital

I mean in general they have a niche.

Aaron Todd

I think their ability to leverage their operations to pay out special dividends or to fund growth is becoming more limited. A couple of our competitors leverage themselves in the four, five times range. It's relative to EBITDA from what we understand and certainly their ability to, if you will go back to the trough to pull out more is probably more challenging. But again, if the primary need for growth is the ability to finance the helicopter, they could probably still get that accomplished within the frame work of their higher leverage profile.

Matt Delefona - Blue Street Capital

Got you. When it comes to getting the machines, I know you guys have a backlog and you have a large advantage in terms of access to the actual units, helicopters to be able to expand. Is that sort of -- that is a big edge for you right now, as you consider growth going forward and taking over more bases et cetera that other people can't do, because they can't get their hands on the machine. What happens when things start to normalize in terms of spending out oil et cetera, all kinds of competitive pressures start to lift from the helicopter industry and everyone can get helicopters, how does that affect your business?

Aaron Todd

That's a great question Matt. I just got back from HAI, the Helicopter Association International conference about a few weeks ago. There is still incredible intensity of demand for [rotoring] assets. We are still looking at two years minimum to procure EMS capable aircraft, if you were to place the order today and in some models, they are still out four and five years. And therefore, I think the question is going to be relevant probably at the earliest 18 to 24 months from now.

I think one of the real advantages that gives us is that we have the ability to be responsive to our hospitals customers and/or hospital customers of competitors who are looking to expand, upgrade their aircraft, rejuvenate their fleet and need to do it quickly, because one of the challenges that's going on is older model aircraft are being starved of the availability of spare parts because of the intense demand for new aircraft production. And therefore, we are seeing customers who are operating legacy ships that are 20 plus years old and they are saying I need to get out of this aircraft in the next six months.

And frankly whenever our competitors just cannot give them that assistance whereas Air Methods says we have that availability and we can get that done. A good example of that was down in town Pennsylvania 4 EC 135 light twin helicopters. We are able to pull that contract from a competitor within a very short time frame because we have those aircrafts available. It wasn't that they didn't have a home. They had a place to go. So we could shift operations in such a way to free up those birds and make them available to a brand new customer and it's those types of opportunities that really work out well for us.

I think the other thing it does for us is that when we are in an environment where twin engine helicopters with the higher cost of fuel are having a hard time staying viable in the market, we have the availability of single engine solutions to drop into those locations, dramatically reduced the cost of our operations and maintain or increase margins rather than abandoning a market or location, merely by adjusting the type of aircraft that we are operating in that location. So that's another advantage. It gives us internally specific to our community-based operation.

So there is no question there are a lot of advantages and more importantly, the fact that we are bringing in 40 plus aircrafts this year at a time when interest rates are extremely low, we are able to lock in those rates at very low pricing. Typically, we are buying the aircraft at below current market rates because we locked in that pricing two, three years ago. And for those aircrafts that they are replacing, there was a very piping hot after-market to get out of our older model aircraft, so they are not seeing on the tarmac waiting for a buyer. We've got good flow of aircrafts out the back door as well which is very important to keeping the fleet modern and efficient in their operating costs.

Matt Delefona - Blue Street Capital

Okay. And when that goes away, what happens when everyone can get helicopter?

Aaron Todd

I mean certainly if everybody can get a helicopter, I think you are going to see more competitiveness in the pricing within the hospital-based contracting services. I think you are going to certainly there maybe some that want to go, saturate a market where they proceed, there might be volume. But the reality is that at a time most of the reasons why my margins in the last couple of years or in 2006 were down within my hospital-based operations, didn't have much to do with availability of aircrafts, as much as it did, that the inflationary influences on the business outpaced the inflators within the contract. So I think that you will see a stabilization of relationships and pricing, but it certainly will increase the competitive posture.

Matt Delefona - Blue Street Capital

Okay. One more and then I promise I'll get back in queue. Just with regards to, and you can combine the answer. You just addressed that the inflationary pricing, fuel is going up, your labor costs are going up, and then at the same time speak to the mix in the quarter as to the reimbursements. And is it still sort of a little bit above trend or it's going to normalize and eventually we'll see a little bit of the squeeze because of the combination of those two, or maybe the other direction?

Aaron Todd

Are you asking about payer mix or you're asking about inflation on the cost side?

Matt Delefona - Blue Street Capital

Both and then the combined effect on margin?

Aaron Todd

As we have monitored the change in payer mix, we've not seen a material shift. Now we all know that, if there is a significant uptick in the unemployment rate then eventually that's going to impact, that's going to create a shift from uninsured into either Medicaid or I mean from insured into either Medicaid or uninsured. And there is a significant delta in collection percentages between those two categories.

So if you see the unemployment rate uptick 2, 3 percentage points, there will be an impact there. And we've measured that impact for each 1% reduction in our collection rate; that's about a $5 million impact to pre-tax earnings. And so if you get about a 1.5% to 2% shift from insured patients into the uninsured patients category, it literally can have that kind of an impact.

Now we do have the ability to adjust pricing to try to compensate for that, but sometimes that's on a lagged basis, and so we can get caught up in a two, three quarter period with that kind of activity, but we are looking hard to make sure that we are tracking that and staying close to it to make sure that our pricing is appropriate not only relative to inflation but also relative to the number of insured patients that were flying.

On the cost side, fuel is the greater known. It's about $13 million, $14 million line item now for us in the aftermath of the CJ acquisition and so we ran about 17% inflation rate in '07 versus '06. And we are probably at a run rate that's above that now, Trent, have you quantified that at all at this point?

Trent Carman

Yeah. It's a little higher than it was.

Aaron Todd

It's very low 20s at this point in time. So we watch that very closely. Payroll is going to be in that mid-single digit range. As you know, our actual maintenance costs per flight actually went down in '07 versus '06, primarily not because the cost of spare parts was going down but because the modernization of the fleet was shifting cost out of the maintenance expense line item and adding less than a $1 reduction on the operating lease line items. So we still think that's a very prudent trend for us to be doing in modernizing the fleet, swapping twins out for singles in certain locations.

And there is a lot of dry powder, Matt. I mean we estimate at these fuel prices that to swap out a twin engine helicopter for a single-engine helicopter can reduce our annual operating expenses by almost $750,000, and if we need to we can certainly do more of that if we can do it without affecting utilization.

Matt Delefona - Blue Street Capital

Is that taking into cost -- is that 750 is that taking into account the cost of capital for deploying money for a new helicopter?

Aaron Todd

Its all in, that’s ownership, that’s insurance, that’s fuel and that’s maintenance, it's the whole thing.

Matt Delefona - Blue Street Capital

Great, all right guys. Thanks for the time. I appreciate it.

Aaron Todd

Sure, Matt.

Operator

(Operator Instructions)

I would now like to turn the call over to Mr. Aaron Todd for closing remarks.

Aaron Todd

Well, thank you for those questions, and again, if some of you actually got a chance to review the 10-K and you have some questions that are spawned from that feel free to give Trent or I a call. And, we look forward to hopefully bumping into you at various conferences and road shows that we have planned coming up and certainly if you are in Denver please drop in and see us. Again, thanks for your support of Air Methods.

Operator

This concludes today's Air Methods' fourth quarter 2007 financial results conference call. You may now disconnect.

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Source: Air Methods Corporation Q4 2007 Earnings Call Transcript
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