The following discussion of the results of operations and financial condition should be read in conjunction with our consolidated financial statements and notes thereto included in Item 8 of this report. This report, including the information incorporated by reference, contains forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. The use of any of the words "believe," "expect," "anticipate," "plan," "estimate," and similar expressions are intended to identify such statements. Forward-looking statements include statements concerning the integration of Sundance; our possible or assumed future results; flight volume and collection rates for patient transports; size, structure and growth of our air medical services and products markets; continuation and/or renewal of hospital contracts; acquisition of new and profitable UR Division contracts; and other matters. The actual results that we achieve may differ materially from those discussed in such forward-looking statements due to the risks and uncertainties described in the Risk Factors contained in Part I, Item 1A of this report, in Management's Discussion and Analysis of Financial Condition and Results of Operations, and in other sections of this report, as well as in our quarterly reports on Form 10-Q. We undertake no obligation to update any forward-looking statements.

Overview

We provide air medical transportation services throughout the United States and design, manufacture, and install medical aircraft interiors and other aerospace and medical transport products. Our divisions, or business segments, are organized according to the type of service or product provided and consist of the following:

· Air Medical Services (AMS) - provides air medical transportation services to the general population as an independent service (also called community-based services) and to hospitals or other institutions under exclusive operating agreements (also called hospital-based services). Patient transport revenue consists of flight fees billed directly to patients, their insurers, or governmental agencies, and cash flow is dependent upon collection from these individuals or entities. Air medical services contract revenue consists of fixed monthly fees (approximately 80% of total contract revenue) and hourly flight fees (approximately 20% of total contract revenue) billed to hospitals or other institutions. In 2012 the AMS Division generated 97% of our total revenue, compared to 95% in 2011 and 96% in 2010.

· United Rotorcraft (UR) Division - designs, manufactures, and installs aircraft medical interiors and other aerospace and medical transport products for domestic and international customers. In 2012 the UR Division generated 3% of our total revenue, compared to 5% in 2011 and 4% in 2010.

See Note 16 to the consolidated financial statements included in Item 8 of this report for operating results by segment.

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

· Flight volume. Almost all of patient transport revenue is derived from flight fees, as compared to approximately 20% of AMS contract revenue. By contrast, 80% of our costs primarily associated with flight operations (including salaries, aircraft ownership costs, hull insurance, and general and administrative expenses) incurred during the year ended December 31, 2012, are mainly fixed in nature. While flight volume is affected by many factors, including competition and the effectiveness of marketing and business development initiatives, the greatest single variable has historically been weather conditions. Adverse weather conditions-such as fog, high winds, or heavy precipitation-hamper our ability to operate our aircraft safely and, therefore, result in reduced flight volume. Total patient transports for community-based locations were approximately 56,000 for 2012 compared to approximately 45,500 for 2011. Patient transports for community-based locations open longer than one year (Same-Base Transports) were approximately 44,900 in 2012 compared to 44,400 in 2011. Cancellations due to unfavorable weather conditions for community-based locations open longer than one year were 1,698 lower in 2012 compared to 2011. Requests for service decreased by 1.2% for the year ended December 31, 2012, for bases open greater than one year.

· Reimbursement per transport. We respond to calls for air medical transports without pre-screening the creditworthiness of the patient and are subject to collection risk for services provided to insured and uninsured patients. Medicare and Medicaid also receive contractual discounts from our standard charges for flight services. Patient transport revenue is recorded net of provisions for contractual discounts and estimated uncompensated care. Both provisions are estimated during the period the related services are performed based on historical collection experience and any known trends or changes in reimbursement rate schedules and payer mix. The provisions are adjusted as required based on actual collections in subsequent periods. Net reimbursement per patient transport is primarily a function of price, payer mix, and timely and effective collection efforts. Both the pace of collections and the ultimate collection rate are affected by the overall health of the U.S. economy, which impacts the number of indigent patients and funding for state-run programs, such as Medicaid. Medicaid reimbursement rates in many jurisdictions have remained well below the cost of providing air medical transportation. In addition, the collection rate is impacted by changes in the cost of healthcare and health insurance; as the cost of healthcare increases, health insurance coverage provided by employers may be reduced, resulting in an increase in the uninsured population. Most of the significant provisions of the PPACA are not scheduled to take effect until 2014, and the impact on our reimbursement rates is, therefore, unknown. Net reimbursement per transport increased 15.1% in the year ended December 31, 2012, compared to 2011, attributed to recent price increases. Provisions for contractual discounts and estimated uncompensated care as a percentage of related gross billings for patient transports were as follows:

                                                 For years ended December 31,
                                               2012            2011          2010
       Gross billings                              100 %           100 %       100 %
       Provision for contractual discounts          45 %            44 %        40 %
       Provision for uncompensated care             19 %            19 %        19 %

Although price increases generally increase the net reimbursement per transport from insurance payers, the amount per transport collectible from private patient payers, Medicare, and Medicaid does not increase proportionately with price increases. Therefore, depending upon overall payer mix, price increases will usually result in an increase in the percentage of uncollectible accounts. Although we have not yet experienced significant increased limitations in the amount reimbursed by insurance companies, continued price increases may cause insurance companies to limit coverage for air medical transport to amounts less than our standard rates. The increase in the percentage of uncollectible accounts in 2012 and 2011 also reflects the addition of Omniflight which had a higher gross charge structure and, therefore, a higher percentage of uncollectible accounts. In addition, the percentage of transports covered by insurance for Omniflight's operations has historically been approximately three to four percentage points lower than the percentage of insured transports for the Company's historical operations. The number of transports covered by insurance decreased from 35.4% of total transports for the year ended December 31, 2011, to 34.5% of total transports for the year ended December 31, 2012, with the decrease moving almost equally to Medicare and private patient payers.

· Aircraft maintenance. AMS operations are directly affected by fluctuations in aircraft maintenance costs. Proper operation of the aircraft by flight crews and standardized maintenance practices can help to contain maintenance costs. Increases in spare parts prices from original equipment manufacturers tend to be higher for aircraft which are no longer in production. Two models of aircraft within our fleet, representing 15% of the rotor wing fleet, are no longer in production and are, therefore, susceptible to price increases which outpace general inflationary trends. In addition, on-condition components are more likely to require replacement with age. Since January 1, 2011, we have taken delivery of 37 new aircraft and have commitments to take delivery of 47 additional aircraft over the next three years. We have replaced discontinued models and other older aircraft with the new aircraft, as well as provided capacity for base expansion. Replacement models of aircraft typically have higher ownership costs than the models targeted for replacement but lower maintenance costs. Total maintenance expense increased 18.1% from the year ended December 31, 2011, to the year ended December 31, 2012, while total flight volume increased 14.5% over the same period. The change in maintenance expense reflects normal fluctuations in the timing of overhaul and replacement cycles for aircraft parts, as well as the acquisition of Omniflight in August 2011.

· Competitive pressures from low-cost providers. We are recognized within the industry for our standard of service and our use of cabin-class aircraft. Many of our competitors utilize aircraft with lower ownership and operating costs and do not require a similar level of experience for aviation and medical personnel. Reimbursement rates established by Medicare, Medicaid, and most insurance providers are not contingent upon the type of aircraft used or the experience of personnel. However, we believe that higher quality standards help to differentiate our service from competitors and, therefore, lead to higher utilization.

· Employee recruitment and relations. The ability to deliver quality services is partially dependent upon our ability to hire and retain employees who have advanced aviation, nursing, and other technical skills. In addition, hospital contracts typically contain minimum certification requirements for pilots and mechanics. Employees who meet these standards are in great demand and are likely to remain a limited resource in the foreseeable future. Our pilots are represented by a collective bargaining unit and are covered under a CBA which is effective through December 31, 2013. Other employee groups may also elect to be represented by unions in the future.

Results of Operations

Year ended December 31, 2012 compared to 2011

We reported net income of $93,152,000 for the year ended December 31, 2012, compared to $46,574,000 for the year ended December 31, 2011. The results for 2012 and for five months of 2011 include the impact of the Omniflight acquisition which closed in August 2011. Net reimbursement per patient transport increased 15.1% in 2012 compared to 2011, while Same-Base Transports were 1.0% higher over the same period.

Air Medical Services

Patient transport revenue is recorded net of provisions for contractual discounts and uncompensated care and increased $174,424,000, or 41.9%, for the year ended December 31, 2012, compared to the year ended December 31, 2011, for the following reasons:
· Net revenue of $74,560,000 from Omniflight's patient transports from January 1, 2012, through July 31, 2012.

· Increase of 15.1% in net reimbursement per transport for the year ended December 31, 2012, compared to 2011, due to the benefit of recent price increases net of the deterioration in payer mix described above.

· Increase of 434, or 1.0%, in Same-Base Transports for the year ended December 31, 2012, compared to 2011. Cancellations due to unfavorable weather conditions for bases open longer than one year were 1,698 lower in 2012 compared to 2011. Requests for service decreased by 1.2% in 2012 for bases open greater than one year.

· Incremental net revenue of $25,991,000 for the year ended December 31, 2012, generated from the addition of nineteen new bases, including seven bases resulting from the conversion of hospital contracts, during either 2012 or 2011.

· Closure of five bases due to insufficient flight volume and the conversion of one base back to hospital-based operations during either 2012 or 2011, resulting in a decrease in net revenue of approximately $7,461,000 during the year ended December 31, 2012.

Air medical services contract revenue increased $18,021,000, or 8.7%, for the year ended December 31, 2012, compared to the year ended December 31, 2011, for the following reasons:
· Net revenue of $13,694,000 from Omniflight's air medical services contracts from January 1, 2012, through July 31, 2012.

· Cessation of service under six contracts and the conversion of three contracts to community-based operations, as well as the closure of certain satellite locations at the option of three current customers, during either 2012 or 2011, resulting in a decrease in net revenue of approximately $18,660,000 for the year ended December 31, 2012.

· Incremental net revenue of $14,792,000 for the year ended December 31, 2012, generated from the addition of three new air medical services contracts, the expansion of eight contracts to additional bases of operation, and the conversion of one community-based location back to hospital-based operations during either 2012 or 2011.

· Decrease of approximately 1.3% in flight volume for the year ended December 31, 2012, for all contracts excluding Omniflight operations from January 1 through July 31, 2012; new contracts; contract expansions; and closed contracts.

· Annual price increases in the majority of contracts based on stipulated contractual increases, changes in the Consumer Price Index or spare parts prices from aircraft manufacturers.

Flight center costs (consisting primarily of pilot, mechanic, and medical staff salaries and benefits) increased $61,805,000, or 23.7%, for the year ended December 31, 2012, compared to 2011, for the following reasons:
· Flight center costs of approximately $41,613,000 related to Omniflight's operations from January 1, 2012, through July 31, 2012.

· Increase of approximately $16,503,000 for the year ended December 31, 2012, for the addition of personnel to staff new base locations described above.

· Decrease of approximately $10,086,000 for the year ended December 31, 2012, due to the closure of base locations described above.

· Increases in salaries for merit pay raises.

Aircraft operating expenses increased $25,308,000, or 20.1%, for the year ended December 31, 2012, in comparison to 2011. Aircraft operating expenses consist of fuel, insurance, and maintenance costs and generally are a function of the size of the fleet, the type of aircraft flown, and the number of hours flown. The increase in costs is due to the following:
· Increase in aircraft maintenance expense of $16,102,000, or 18.1%, to $105,142,000. Total flight volume increased 14.5% for 2012 compared to 2011. The change in maintenance expense reflects normal fluctuations in the timing of overhaul and replacement cycles for aircraft parts.

· Increase of approximately 8.2% in the cost of aircraft fuel per hour flown. Total fuel costs increased $6,075,000 to $25,623,000 for 2012 compared to 2011. During both 2012 and 2011 we had commodity call options to protect against aircraft fuel price increases greater than 20%, covering approximately 86% of our fuel consumption for 2012 and essentially all of our consumption in 2011. Fuel expense included non-cash mark to market derivative losses of $257,000 for 2012 compared to $800,000 for 2011. Cash settlements under the terms of the agreements totaled $1,131,000 in 2011. We received no cash settlements under the agreements in 2012.

· Decreases in hull insurance rates effective July 2012 and 2011.

· Incremental aircraft operating expenses related to the Omniflight fleet were approximately $18,410,000 from January 1, 2012 through July 31, 2012.

United Rotorcraft Division

Medical interiors and products revenue decreased $1,630,000, or 5.4%, for the year ended December 31, 2012, compared to 2011. Significant projects in process during 2012 included fifty multi-mission interiors for the U.S. Army's HH-60M helicopter and ten aircraft medical interiors for commercial customers. Revenue by product line for the year ended December 31, 2012, was as follows:
· $14,460,000 - governmental entities

· $14,372,000 - commercial customers

Significant projects in process during 2011 included work under two contracts to produce a total of fifty multi-mission interiors for the U.S. Army's HH-60M helicopter, 53 interiors for an older generation of the U.S. Army's Blackhawk helicopter, approximately 187 MEV litter systems, and seven aircraft medical interior kits for commercial customers. Revenue by product line for the year ended December 31, 2011, was as follows:
· $21,160,000 - governmental entities

· $9,302,000 - commercial customers

Cost of medical interiors and products decreased $564,000, or 2.6%, for the year ended December 31, 2012, as compared to the previous year, due primarily to changes in sales volume and product mix. Costs in 2012 also included development and design work on aircraft interior configurations for commercial customers, leading to higher engineering and certification costs and to lower profit margins.

General Expenses

Depreciation and amortization expense increased $9,647,000, or 13.2%, for the year ended December 31, 2012. Incremental depreciation related to Omniflight's fixed assets, including aircraft under capital leases, was approximately $5,547,000, and amortization of Omniflight's intangible assets totaled $2,301,000 from January 1, 2012, through July 31, 2012. In addition, from the fourth quarter of 2011 through the end of 2012, we added 30 aircraft subject to capital leases, totaling approximately $60.3 million, to our depreciable assets.

General and administrative (G&A) expenses increased $16,523,000, or 19.3%, for the year ended December 31, 2012, compared to 2011. G&A expenses include executive management, accounting and finance, billing and collections, information services, human resources, aviation management, pilot training, dispatch and communications, and AMS program administration. G&A expenses were 12.0% of revenue for 2012, compared to 12.9% of revenue for 2011. During the first quarter of 2012, we completed the consolidation of the Part 135 Air Carrier Certificate for Omniflight into the Air Methods certificate and completed the process of integrating other Omniflight overhead functions into existing departments. G&A expenses for 2012 also included $9,451,000 for severance related to the elimination of the chief operating officer position and incentive compensation accruals related to our financial performance. Expense related to incentive compensation totaled approximately $4,567,000 in 2011. Expenses for 2011 also included approximately $2,283,000 in transaction costs and employee severance related to the acquisition of Omniflight. We also incurred approximately $1,678,000 in expenses during the fourth quarter of 2011 related to transitioning Omniflight's G&A functions into existing Air Methods departments.

Interest expense increased $579,000, or 2.9%, for the year ended December 31, 2012, compared to 2011. The increase is primarily due to interest recorded on capital lease obligations, totaling approximately $17.0 million as of December 31, 2012, assumed in the Omniflight acquisition and to interest incurred on the $200 million term loan originated in July 2011 to fund the acquisition of Omniflight. The term loan bears interest at a variable rate which averaged 2.2% for the year ended December 31, 2012, compared to 2.4% for the year ended December 31, 2011. In addition, we carried an average balance of $24.4 million against our line of credit during 2012, compared to $1.6 million in 2011. The line of credit bears interest at a variable rate which averaged 3.1% for 2012. These increases were offset in part by the effect of reduction in principal balances for long-term debt and capital lease obligations as a result of regularly scheduled payments; lease buyouts relating to obligations totaling $51.2 million; and the payoff of our previous $50 million term loan in July 2011.

Income tax expense was $59,792,000, or 39.1% of income before taxes in 2012 and $30,728,000, or 39.8% of income before taxes in 2011. The rate in 2012 was affected by apportionment factor adjustments which increased our expected blended state rate; applying the new rate to deferred tax assets and liabilities resulted in income tax expense of $667,000 for the year ended December 31, 2012. Excluding the effect of this change, the effective tax rate was 38.7% in 2012. The decrease in this adjusted rate compared to 2011 is primarily the result of a decrease in certain permanent book-tax differences. Changes in our effective tax rate are affected by the apportionment of revenue and income before taxes to the various jurisdictions in which we operate and by changing tax laws and regulations in those jurisdictions.

Year ended December 31, 2011 compared to 2010

We reported net income of $46,574,000 for the year ended December 31, 2011, compared to $42,757,000 for the year ended December 31, 2010. The results for 2011 include the impact of the Omniflight acquisition effective August 1, 2011. Net reimbursement per patient transport increased 10.6% in 2011 compared to 2010, while Same-Base Transports were 6.9% lower over the same period.

Air Medical Services

Patient transport revenue increased $86,443,000, or 26.2%, for the year ended December 31, 2011, compared to 2010, for the following reasons:
· Net revenue of $49,474,000 from Omniflight's patient transports from the acquisition date through December 31, 2011.

· Increase of 10.6% in net reimbursement per transport for year ended December 31, 2011, compared to 2010, due to the benefit of recent price increases net of the change in payer mix resulting from the Omniflight acquisition described above.

· Decrease of 2,718, or 6.9%, in Same-Base Transports for the year ended December 31, 2011, compared to 2010. Cancellations due to unfavorable weather conditions for locations open longer than one year were 508 higher in 2011 compared to 2010. Requests for service decreased by 4.5% in 2011 for bases open greater than one year.

· Incremental net revenue of $26,135,000 for the year ended December 31, 2011, generated from the addition of nineteen new bases, including eleven bases resulting from the conversion of hospital contracts, during either 2011 or 2010.

· Closure of three bases during 2010 and one during 2011 due to insufficient flight volume, resulting in a decrease in net revenue of approximately $4,431,000 during the year ended December 31, 2011.

Air medical services contract revenue increased $2,934,000, or 1.4%, for the year ended December 31, 2011, compared to 2010, for the following reasons:
· Net revenue of $11,987,000 from Omniflight's air medical services contracts from the acquisition date through December 31, 2011.

· Cessation of service under three contracts and the conversion of five contracts to community-based services during either 2011 or 2010, resulting in a decrease in net revenue of approximately $16,903,000 for the year ended December 31, 2011.

· Incremental net revenue of $5,771,000 for the year ended December 31, 2011, generated from the expansion of six contracts to additional bases of operation during either 2011 or 2010 and from the conversion of one community-based location back to hospital-based operations in 2011.

· Decrease of 2.2% in flight volume for the year ended December 31, 2011, for all contracts excluding contract expansions and closed contracts discussed above, as well as Omniflight's air medical services contracts from the acquisition date through December 31, 2011.

· Annual price increases in the majority of contracts based on stipulated contractual increases, changes in the Consumer Price Index or spare parts prices from aircraft manufacturers.

Flight center costs increased $44,271,000, or 20.5%, to $260,363,000 for the year ended December 31, 2011, compared to 2010. During the fourth quarter of 2011, we recorded $2,179,000 for retroactive adjustments in pay resulting from the new CBA negotiated with our pilots and $600,000 in additional workers compensation expense related to a fatal accident experienced in 2011. Increase is due to the following:
· Flight center costs of approximately $28,817,000 related to Omniflight's operations from the acquisition date through December 31, 2011.

· Increase of approximately $12,633,000 for the year ended December 31, 2011, for the addition of personnel to staff new base locations described above.

· Decrease of approximately $8,008,000 for the year ended December 31, 2011, due to the closure of base locations described above.

· Increases in salaries for merit pay raises and in the cost of employee medical benefits.

Aircraft operating expenses increased $11,783,000, or 10.3%, for the year ended December 31, 2011, in comparison to 2010, for the following reasons:
· Increase in aircraft maintenance expense of $4,328,000, or 5.1%, to $89,040,000. Total flight volume increased 13.1% for 2011 compared to 2010. Excluding the impact of the Omniflight fleet, aircraft maintenance expense decreased 7.2% for 2011 compared to 2010, and total flight volume, excluding the Omniflight fleet, increased 1.4%. The decrease in maintenance expense reflects normal fluctuations in the timing of overhaul and replacement cycles for aircraft parts. In addition, during 2011 we became qualified to bring repairs and overhauls of certain aircraft engines in-house, resulting in a decrease of approximately 20% in the repair costs associated with this engine type.

· Increase of approximately 28.1% in the cost of aircraft fuel per hour flown. Total fuel costs increased $6,247,000 to $19,548,000 for 2011 compared to 2010. During both 2011 and 2010 we had commodity call options to protect against aircraft fuel price increases greater than 20%, covering essentially all of our fuel consumption for 2011, excluding the impact of the Omniflight fleet, and approximately 97% of our consumption in 2010. Fuel expense included non-cash mark to market derivative losses of $800,000 for 2011 compared to $181,000 for 2010. Cash settlements under the terms of the agreements totaled $1,131,000 in 2011. We received no cash settlements under the agreements in 2010.

· Decreases in hull insurance rates effective July 2011 and 2010.

· Total aircraft operating expenses related to the Omniflight fleet were approximately $15,480,000 from the acquisition date through December 31, 2011.

United Rotorcraft Division

Medical interiors and products revenue increased $8,015,000, or 35.7%, from $22,447,000 for the year ended December 31, 2010, to $30,462,000 for the year ended December 31, 2011. Significant projects in process during 2011 included . . .