form10q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________________ to _______________________
Commission File Number 1-8865
SIERRA HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)
NEVADA 88-0200415
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2724 NORTH TENAYA WAY
LAS VEGAS, NV 89128
(Address of principal executive offices) (Zip Code)
(702) 242-7000
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since
last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No --- ---
As of August 1, 2001, there were 27,871,000 shares of common stock outstanding.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
FORM 10-Q FOR THE SIX MONTHS ENDED JUNE 30, 2001
INDEX
Page No.
--------
Part I - FINANCIAL INFORMATION
Item l. Financial Statements
Condensed Consolidated Balance Sheets -
June 30, 2001 and December 31, 2000...................................................... 3
Condensed Consolidated Statements of Operations -
three and six months ended June 30, 2001 and 2000........................................ 4
Condensed Consolidated Statements of Cash Flows -
six months ended June 30, 2001 and 2000.................................................. 5
Notes to Condensed Consolidated Financial Statements....................................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............................................ 12
Item 3. Quantitative and Qualitative Disclosures
about Market Risk........................................................................ 23
Part II - OTHER INFORMATION
Item l. Legal Proceedings.......................................................................... 24
Item 2. Changes in Securities and Use Of Proceeds.................................................. 24
Item 3. Defaults Upon Senior Securities............................................................ 24
Item 4. Submission of Matters to a Vote of Security Holders........................................ 24
Item 5. Other Information.......................................................................... 25
Item 6. Exhibits and Reports on Form 8-K........................................................... 25
Signatures................................................................................................... 26
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
ASSETS
June 30 December 31
2001 2000
Unaudited
CURRENT ASSETS:
Cash and Cash Equivalents.............................................. $ 131,447 $ 161,306
Investments............................................................ 212,071 207,143
Accounts Receivable (Less Allowance for Doubtful
Accounts: 2001 - $16,352; 2000 - $17,996).......................... 28,827 33,094
Military Accounts Receivable (Less Allowance for Doubtful
Accounts: 2001 - $1,316; 2000 - $1,212)............................ 40,377 71,390
Current Portion of Deferred Tax Asset.................................. 48,093 46,702
Current Portion of Reinsurance Recoverable............................. 93,289 92,867
Prepaid Expenses and Other Current Assets.............................. 33,974 33,559
Assets Held for Sale................................................... 19,484 22,942
---------- ----------
Total Current Assets............................................... 607,562 669,003
PROPERTY AND EQUIPMENT, NET................................................. 164,159 173,031
LONG-TERM INVESTMENTS....................................................... 9,172 18,093
RESTRICTED CASH AND INVESTMENTS............................................. 27,034 24,724
REINSURANCE RECOVERABLE, Net of Current Portion............................. 172,382 160,227
DEFERRED TAX ASSET, Net of Current Portion.................................. 74,893 68,253
OTHER ASSETS................................................................ 63,434 51,769
---------- ----------
TOTAL ASSETS................................................................ $1,118,636 $1,165,100
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts Payable and Accrued Liabilities.................................. $ 98,503 $ 109,696
Medical Claims Payable.................................................... 106,196 112,296
Current Portion of Reserve for Losses and Loss Adjustment Expense ........ 142,935 134,676
Unearned Premium Revenue.................................................. 59,815 48,373
Military Health Care Payable.............................................. 80,719 84,859
Premium Deficiency Reserve................................................ 6,142 14,466
Current Portion of Long-term Debt......................................... 43,175 88,223
---------- ----------
Total Current Liabilities............................................ 537,485 592,589
RESERVE FOR LOSSES AND
LOSS ADJUSTMENT EXPENSE, Net of Current Portion........................... 256,124 239,878
LONG-TERM DEBT, Net of Current Portion...................................... 208,816 225,355
OTHER LIABILITIES .......................................................... 20,658 16,805
---------- ----------
TOTAL LIABILITIES........................................................... 1,023,083 1,074,627
---------- ----------
STOCKHOLDERS' EQUITY:
Preferred Stock, $.01 Par Value, 1,000
Shares Authorized; None Issued or Outstanding
Common Stock, $.005 Par Value, 60,000
Shares Authorized; Shares Issued: 2001 - 29,043; 2000 - 28,815...... 145 144
Additional Paid-in Capital................................................ 178,161 177,493
Treasury Stock; 2001 and 2000 - 1,523 Common Stock Shares................. (22,789) (22,789)
Accumulated Other Comprehensive Loss...................................... (7,256) (5,667)
Accumulated Deficit....................................................... (52,708) (58,708)
---------- ----------
Total Stockholders' Equity........................................... 95,553 90,473
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................. $1,118,636 $1,165,100
========== ==========
See accompanying notes to condensed consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
Unaudited
Three Months Ended June 30 Six Months Ended June 30
2001 2000 2001 2000
OPERATING REVENUES:
Medical Premiums................................... $218,402 $ 219,751 $430,582 $ 438,429
Military Contract Revenues......................... 88,086 72,374 169,998 137,255
Specialty Product Revenues......................... 44,901 30,090 86,327 58,114
Professional Fees.................................. 7,746 9,695 15,075 20,716
Investment and Other Revenues...................... 5,201 5,144 11,843 9,716
-------- --------- -------- ---------
Total............................................ 364,336 337,054 713,825 664,230
-------- --------- -------- ---------
OPERATING EXPENSES:
Medical Expenses (Note 2).......................... 192,977 246,969 374,505 439,307
Military Contract Expenses......................... 86,333 70,150 166,771 132,983
Specialty Product Expenses......................... 45,555 46,884 89,426 73,732
General, Administrative and Marketing
Expenses......................................... 37,523 34,656 71,199 68,985
Restructuring, Reorganization and
Other Costs (Notes 2 and 3)....................... (7,800) 217,540 (7,800) 220,440
-------- --------- -------- ---------
Total ............................................ 354,588 616,199 694,101 935,447
-------- --------- -------- ---------
OPERATING INCOME (LOSS).............................. 9,748 (279,145) 19,724 (271,217)
INTEREST EXPENSE AND OTHER, NET .................... (5,545) (5,149) (10,702) (10,737)
-------- --------- -------- ---------
INCOME (LOSS) BEFORE INCOME TAXES.................... 4,203 (284,294) 9,022 (281,954)
BENEFIT (PROVISION) FOR INCOME TAXES................. (1,408) 77,577 (3,022) 76,793
-------- --------- -------- ---------
NET INCOME (LOSS).................................... $ 2,795 $(206,717) $ 6,000 $(205,161)
======== ========= ======== =========
NET INCOME (LOSS) PER COMMON SHARE................... $.10 $(7.64) $.22 $(7.59)
==== ====== ==== ======
NET INCOME (LOSS) PER COMMON SHARE
ASSUMING DILUTION................................... $.10 $(7.64) $.22 $(7.59)
==== ====== ==== ======
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING......................................... 27,515 27,041 27,501 27,013
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING ASSUMING DILUTION....................... 28,002 27,041 27,895 27,013
See accompanying notes to condensed consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Unaudited
Six Months Ended June 30
2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss)....................................................... $ 6,000 $(205,161)
Adjustments to Reconcile Net Income (Loss) to Net Cash
Provided by (Used for) Operating Activities:
Provision for Asset Impairment and Other Charges................. 202,951
Depreciation and Amortization.................................... 12,494 17,673
Provision for Doubtful Accounts.................................. 1,337 2,173
Loss on Property and Equipment Dispositions...................... 2,369
Changes in Assets and Liabilities....................................... 17,374 (37,679)
-------- ---------
Net Cash Provided by (Used for) Operating Activities ........ 39,574 (20,043)
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures, Net of Dispositions............................... (2,128) (10,894)
Changes in Investments.................................................. (6,387) 17,014
-------- ---------
Net Cash (Used for) Provided by Investing Activities......... (8,515) 6,120
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Borrowings................................................ 25,000
Payments on Debt and Capital Leases..................................... (61,587) (5,427)
Issuance of Stock in Connection with Stock Plans........................ 669 900
-------- ---------
Net Cash (Used for) Provided by Financing Activities......... (60,918) 20,473
-------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS....................... (29,859) 6,550
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD........................... 161,306 55,936
-------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD................................. $131,447 $ 62,486
======== =========
Six Months Ended June 30
Supplemental Condensed Consolidated
Statements of Cash Flows Information: 2001 2000
Cash Paid During the Period for Interest
(Net of Amount Capitalized)............................................. $11,896 $11,613
Net Cash (Paid) Received During the Period for Income Taxes................ (45) 10,773
Non-cash Investing and Financing Activities:
Note Received for Sale of Investment.................................... 3,700
Debentures exchanged.................................................... 19,692
See accompanying notes to condensed consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The accompanying unaudited financial statements include the consolidated
accounts of Sierra Health Services, Inc. ("Sierra", a holding company,
together with its subsidiaries, collectively referred to herein as the
"Company"). All material intercompany balances and transactions have been
eliminated. These statements have been prepared in conformity with
accounting principles generally accepted in the United States of America
and used in preparing the Company's annual audited consolidated financial
statements but do not contain all of the information and disclosures that
would be required in a complete set of audited financial statements. They
should, therefore, be read in conjunction with the Company's annual audited
consolidated financial statements and related notes thereto for the years
ended December 31, 2000 and 1999. In the opinion of management, the
accompanying unaudited condensed consolidated financial statements reflect
all adjustments, consisting only of normal recurring adjustments, necessary
for a fair presentation of the financial results for the interim periods
presented.
2. Certain Medical Expenses
In the first quarter of 2000, the Company recorded $1.0 million of prior
period reserve strengthening. Included in reported medical expenses for the
second quarter of 2000 are changes in estimate charges of $29.5 million of
reserve strengthening primarily due to adverse development on prior
periods' medical claims, as well as $15.5 million in premium deficiency
medical expense related to under-performing markets in the Dallas/Ft. Worth
and Houston areas. The recorded premium deficiency reflects anticipated
cost savings from restructuring and reorganization actions discussed below.
In addition, the Company recorded $10.2 million of other non-recurring
medical costs primarily relating to the write-down of medical subsidiary
assets.
The total premium deficiency medical reserve utilized during the first and
second quarters of 2001 was $2.1 million and $4.9 million, respectively.
During the second quarter of 2001, management revised their estimates of
premium deficiency reserves and reclassified $7.8 million from premium
deficiency maintenance reserve to premium deficiency medical reserve. This
reclassification was based on the latest available medical cost trends,
which did not become evident until the second quarter of 2001, and is
reflected as an increase in medical expense and a decrease in restructuring
reorganization and other costs on the condensed consolidated statement of
operations. Management believes that the total premium deficiency reserve
of $6.1 million, as of June 30, 2001, is appropriate and that no further
revision to the estimate is necessary at this time. Of the $6.1 million
remaining reserve, $6.0 million has been designated as a premium deficiency
medical reserve.
3. Asset Impairment, Restructuring, Reorganization and Other Costs
The table below presents a summary of asset impairment, restructuring,
reorganization and other costs for the periods indicated.
Restructuring Premium
Asset and Deficiency
(In thousands) Impairment Reorganization Maintenance Other Total
Balance, January 1, 2000........... $ 11,000 $ 3,449 $ 14,449
Charges recorded................... $ 190,490 $ 13,492 10,358 6,100 220,440
Cash used.......................... (9,143) (12,080) (502) (21,725)
Noncash activity................... (190,490) (3,800) (194,290)
Changes in estimate................ _________ ________ _________ ________ _________
Balance, December 31, 2000......... - 4,349 9,278 5,247 18,874
Charges recorded................... -
Cash used.......................... (1,960) (1,330) (800) (4,090)
Noncash activity................... -
Changes in estimate................ _________ ________ (7,800) ________ (7,800)
--------- ----------
Balance, June 30, 2001............. $ - $ 2,389 $ 148 $ 4,447 $ 6,984
========= ======== ========= ======== =========
As discussed in Note 2 of the Notes to Condensed Consolidated Financial
Statements, in the second quarter of 2001, management re-evaluated the
premium deficiency reserve and reclassified $7.8 million from premium
deficiency maintenance to premium deficiency medical.
The remaining restructuring and reorganization costs of $2.4 million are
primarily related to the cost to provide malpractice insurance on our
discontinued affiliated medical groups and lease terminations in Houston
and Arizona. The remaining other costs of $4.4 million are primarily
related to legal claims. Management believes that the remaining reserves,
as of June 30, 2001, are appropriate and that no further revisions to the
estimates are necessary at this time.
4. The following table provides a reconciliation of basic and diluted earnings
per share ("EPS"):
Dilutive
(In thousands, except per share data) Basic Stock Options Diluted
For the Three Months ended June 30, 2001:
Income from Continuing Operations $ 2,795 $ 2,795
Shares 27,515 487 28,002
Per Share Amount $.10 $.10
For the Three Months ended June 30, 2000:
Loss from Continuing Operations $(206,717) $(206,717)
Shares 27,041 27,041
Per Share Amount $(7.64) $(7.64)
For the Six Months ended June 30, 2001:
Income from Continuing Operations $6,000 $6,000
Shares 27,501 394 27,895
Per Share Amount $.22 $.22
For the Six Months ended June 30, 2000:
Loss from Continuing Operations $(205,161) $(205,161)
Shares 27,013 27,013
Per Share Amount $(7.59) $(7.59)
CII Financial, Inc., a wholly owned subsidiary of the Company, has
outstanding 7 1/2% convertible subordinated debentures (the
"Subordinated Debentures") due September 15, 2001. Each $1,000 in
principal is convertible into 25.382 shares of the Company's common
stock at a conversion price of $39.398 per share. The Subordinated
Debentures were not included in the computation of EPS because their
effect would be antidilutive. Outstanding stock options were not
included in the computation of diluted EPS in 2000 because their
effect would have been antidilutive.
5. The following table presents comprehensive income for the periods
indicated:
Three Months Ended June 30 Six Months Ended June 30
(In thousands) 2001 2000 2001 2000
NET INCOME (LOSS)......................... $2,795 $(206,717) $6,000 $(205,161)
Change in Accumulated Other
Comprehensive Income (Loss)............. (2,558) (224) (1,589) 3,850
------ --------- ------ ---------
COMPREHENSIVE INCOME (LOSS)............... $ 237 $(206,941) $4,411 $(201,311)
====== ========= ====== =========
6. Segment Reporting
The Company has three reportable segments based on the products and
services offered: managed care and corporate operations, military health
services operations and workers' compensation operations. The managed care
and corporate segment includes managed health care services provided
through HMOs, managed indemnity plans, third-party administrative services
programs for employer-funded health benefit plans, multi-specialty medical
groups, other ancillary services and corporate operations. The military
health services segment administers a five-year, managed care federal
contract for the Department of Defense's TRICARE program in Region 1. The
workers' compensation segment assumes workers' compensation claims risk in
return for premium revenues and third party administrative services.
The Company evaluates each segment's performance based on segment operating
profit. The accounting policies of the operating segments are the same as
those of the consolidated company, except as described in the notes below.
Information concerning the operations of the reportable segments is as follows:
(In thousands)
Managed Care Military Workers'
and Corporate Health Services Compensation
Operations Operations Operations Total
Three Months Ended June 30, 2001
Medical Premiums............................. $ 218,402 $ 218,402
Military Contract Revenues................... $ 88,086 88,086
Specialty Product Revenues................... 1,933 $ 42,968 44,901
Professional Fees............................ 7,746 7,746
Investment and Other Revenues................ 697 641 3,863 5,201
--------- -------- -------- ---------
Total Revenue............................. $ 228,778 $ 88,727 $ 46,831 $364,336
========= ======== ======== =========
Segment Operating Profit (1)................. $ 4,988 $ 2,394 $ 2,366 $ 9,748
Interest Expense and Other, Net.............. (5,661) 116 (5,545)
Changes in Estimate Charges (2).............. (7,800) (7,800)
Restructuring, Reorganization and Other Costs 7,800 7,800
--------- -------- -------- ----------
Net (Loss) Income Before Income Taxes........ $ (673) $ 2,394 $ 2,482 $ 4,203
========= ======== ======== =========
Three Months Ended June 30, 2000
Medical Premiums............................. $ 219,751 $ 219,751
Military Contract Revenues................... $ 72,374 72,374
Specialty Product Revenues................... 2,370 $ 27,720 30,090
Professional Fees............................ 9,695 9,695
Investment and Other Revenues................ 1,301 252 3,591 5,144
--------- -------- -------- ---------
Total Revenue............................. $ 233,117 $ 72,626 $ 31,311 $ 337,054
========= ======== ======== =========
Segment Operating Profit (1)................. $ 5,154 $ 2,477 $ 1,061 $ 8,692
Interest Expense and Other, Net.............. (4,874) (123) (152) (5,149)
Changes in Estimate Charges (2).............. (55,297) (15,000) (70,297)
Restructuring, Reorganization and Other Costs (214,540) (3,000) 217,540
--------- -------- -------- ---------
Net (Loss) Income Before Income Taxes........ $(269,557) $ 2,354 $(17,091) $(284,294)
========= ======== ======== =========
Six Months Ended June 30, 2001
Medical Premiums............................. $ 430,582 $ 430,582
Military Contract Revenues................... $169,998 169,998
Specialty Product Revenues................... 3,905 $ 82,422 86,327
Professional Fees............................ 15,075 15,075
Investment and Other Revenues................ 2,304 1,162 8,377 11,843
--------- -------- -------- ---------
Total Revenue............................. $ 451,866 $171,160 $ 90,799 $ 713,825
========= ======== ======== =========
Segment Operating Profit (1)................. $ 11,632 $ 4,389 $ 3,703 $ 19,724
Interest Expense and Other, Net.............. (9,922) (17) (763) (10,702)
Changes in Estimate Charges (2).............. (7,800) (7,800)
Restructuring, Reorganization and Other Costs 7,800 7,800
---------- -------- -------- ---------
Net Income Before Income Taxes............... $ 1,710 $ 4,372 $ 2,940 $ 9,022
========= ======== ======== =========
Six Months Ended June 30, 2000
Medical Premiums............................. $ 438,429 $ 438,429
Military Contract Revenues................... $137,255 137,255
Specialty Product Revenues................... 4,692 $ 53,422 58,114
Professional Fees............................ 20,716 20,716
Investment and Other Revenues................ 2,296 454 6,966 9,716
--------- -------- -------- ---------
Total Revenue............................. $ 466,133 $137,709 $ 60,388 $ 664,230
========= ======== ======== =========
Segment Operating Profit (1)................. $ 10,799 $ 4,727 $ 6,494 $ 22,020
Interest Expense and Other, Net.............. (9,402) (365) (970) (10,737)
Changes in Estimate Charges (2).............. (56,297) (16,500) (72,797)
Restructuring, Reorganization and Other Costs (217,440) (3,000) (220,440)
--------- -------- -------- ----------
Net (Loss) Income Before Income Taxes........ $(272,340) $ 4,362 $(13,976) $(281,954)
========= ========= ======== =========
(1) The segment operating profit excludes the effects of changes in estimate
charges.
(2) Represents changes in estimate charges in the current year for services or
liabilities of a prior year that are reclassified to either Medical
Expenses or Specialty Product Expenses for presentation in accordance with
accounting principles generally accepted in the United States of America.
7. CII Financial Debentures
CII Financial, Inc., had outstanding, $47.0 million of Subordinated
Debentures that are due on September 15, 2001. These Subordinated
Debentures were neither assumed nor guaranteed by Sierra and were
subordinated to Sierra's credit facility debt. In December 2000, CII
Financial commenced an exchange offer to exchange the Subordinated
Debentures for cash and/or new debentures. On May 7, 2001, CII Financial
closed its exchange offer on $42.1 million of its outstanding Subordinated
Debentures. CII Financial purchased $27.1 million in principal amount of
Subordinated Debentures for $20.0 million in cash and issued $15.0 million
in new 9 1/2% senior debentures, due September 15, 2004, in exchange for
$15.0 million in Subordinated Debentures. CII Financial has $5.0 million in
Subordinated Debentures that remain outstanding.
The exchange offer proposed concessions by the holders of the Subordinated
Debentures, including extending the maturity and accepting an interest rate
that may have been lower than what CII Financial could have obtained from
other lenders. In accordance with accounting principles generally accepted
in the United States of America, the exchange of the new 9 1/2% senior
debentures for the Subordinated Debentures is treated as a restructuring of
debt. Additionally, the Subordinated Debentures are considered to represent
one payable, even though there are many debenture holders. Although some of
the debenture holders exchanged the Subordinated Debentures for cash, some
exchanged them for new 9 1/2% senior debentures and others a combination of
the two, this does not change the substance of the transaction for CII
Financial; accordingly, the exchange is considered to be a single
transaction.
In the transaction, total future cash payments (interest and principal) on
the remaining Subordinated Debentures and the new 9 1/2% senior debentures
are less than the balance of the Subordinated Debentures at the time of the
exchange less the cash consideration given in the exchange. Accordingly,
under SFAS No. 15, a gain on restructuring was recognized for the
difference and the carrying amount of the remaining Subordinated Debentures
and new 9 1/2% senior debentures is the total future cash payments on the
debentures. Costs incurred in connection with the exchange were used to
offset the gain on restructuring. All future cash payments related to the
debentures will be reductions of the carrying amount of the debentures and
no interest expense will be recognized for the debentures. The transaction
resulted in a gain of $712,000.
The new 9 1/2% senior debentures pay interest, which is due semi-annually
on March 15 and September 15 of each year, commencing on September 15,
2001. The new 9 1/2% senior debentures rank senior to outstanding notes
payable from CII Financial to Sierra, the remaining Subordinated Debentures
and CII Financial's guarantee of Sierra's revolving credit facility. The
new 9 1/2% senior debentures may be redeemed by CII Financial at any time
at premiums starting at 110% and declining to 100% for redemptions after
April 1, 2004. In the event of a change in control of CII Financial, the
holders of these new 9 1/2% senior debentures may require that CII
Financial repurchase them at the then applicable redemption price, plus
accrued and unpaid interest.
8. Recent Accounting Pronouncements:
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 141, "Business
Combinations" ("SFAS 141"). SFAS 141 requires the purchase method of
accounting for business combinations initiated after June 30, 2001 and
eliminates the pooling-of-interests method. The Company does not believe
that the adoption of SFAS 141 will have a significant impact on its
financial statements.
In July 2001, the FASB issued Statement of Financial Accounting Standards
No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which is
effective January 1, 2002. SFAS 142 requires, among other things, the
discontinuance of goodwill amortization. Goodwill amortized in the six
months ended June 30, 2001 was $405,000. In addition, the standard includes
provisions for the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. SFAS 142
also requires the Company to complete a transitional goodwill impairment
test six months from the date of adoption. The net amortized goodwill
balance at June 30, 2001 was $15.2 million and the Company is currently
assessing, but has not yet determined, the impact of SFAS 142 on its
financial position and results of operations.
9. Certain amounts in the Condensed Consolidated Financial Statements for the
three and six months ended June 30, 2000 have been reclassified to conform
with the current year presentation.
SIERRA HEALTH SERVICES, INC. AND SUBSIDAIRES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis provides information which management
believes is relevant for an assessment and understanding of our consolidated
financial condition and results of operations. The discussion should be read in
conjunction with the Condensed Consolidated Financial Statements and related
Notes thereto. Any forward-looking information contained in this Management's
Discussion and Analysis of Financial Condition and Results of Operations and any
other sections of this Quarterly Report on Form 10-Q should be considered in
connection with certain cautionary statements contained in our Current Report on
Form 8-K filed March 20, 2001, which is incorporated by reference. Such
cautionary statements are made pursuant to the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 and identify important risk
factors that could cause our actual results to differ materially from those
expressed in any projected, estimated or forward-looking statements relating to
us.
RESULTS OF OPERATIONS, THREE MONTHS ENDED JUNE 30, 2001, COMPARED TO THREE
MONTHS ENDED JUNE 30, 2000.
Total Operating Revenues for 2001 increased approximately 8.1% to $364 million
from $337 million for 2000.
The change in operating revenues was comprised of the following:
o A decrease in medical premiums of $1.3 million
o An increase in military contract revenues of $15.7 million
o An increase in specialty product revenues of $14.8 million
o A decrease in professional fees of $1.9 million
Medical premiums accounted for approximately 59.9% and 65.2% of our total
revenues for 2001 and 2000, respectively. The decrease in medical premiums as a
percentage of total revenues in 2001 are primarily due to the increase in
specialty product and military contract revenues and the decrease in premium
revenue due to the decrease in commercial HMO membership in Texas. Medical
premium revenue growth is principally dependent upon continued enrollment in our
products and upon competitive and regulatory factors.
Medical Premiums decreased $1.3 million or .6%. The decrease in premium revenue
reflects an 18.4% decrease in commercial member months (the number of months of
each year that an individual is enrolled in a plan) offset by a 7.8% increase in
Medicare member months. The decrease in commercial member months is primarily
related to the sale of our Houston HMO membership during the fourth quarter of
2000. Excluding the Texas operations, premium revenue increased by $11.5 million
or 7.2%, Medicare member months increased by 6.7% and commercial member months
increased by 1.5%. The growth in Medicare member months contributes
significantly to increases in premium revenues as the Medicare per member
premium rates are over three times higher than the average commercial premium
rate. The average commercial rate increases in 2001 on renewed groups are
approximately 8% and 16% in Las Vegas and Dallas/Ft. Worth, respectively. Our
managed indemnity rates increased approximately 6.7% and Medicare rates
increased approximately 4.0%, of which a portion is attributable to an increase
in member benefits. Over 97% of our Las Vegas, Nevada Medicare beneficiaries are
enrolled in the Social HMO Medicare program.
We market our HMO and managed indemnity insurance products primarily to employer
groups, labor unions and individuals enrolled in Medicare, through our internal
sales personnel and independent insurance brokers. Our brokers receive
commissions based on the premiums received from each group. Our agreements with
our member groups are usually for twelve months and are subject to annual
renewal. For the quarter ended June 30, 2001, our ten largest commercial HMO
employer groups were,
SIERRA HEALTH SERVICES, INC. AND SUBSIDAIRES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OPERATIONS
in the aggregate, responsible for less than 10% of our total revenues. Although
none of the employer groups accounted for more than 2% of total revenues for
that period, the loss of one or more of the larger employer groups could, if not
replaced with similar membership, have a material adverse effect on our
business.
Military Contract Revenues increased $15.7 million or 21.7%. The increase in
revenue is the result of additive change order work. The revenue increase is
significantly offset by increased military contract expenses. The change orders
recently implemented include a prescription drug program for beneficiaries over
age 65 and the waiver of co-payments for active duty family members. Military
contract revenue is recorded based on the contract price as agreed to by the
federal government, adjusted for certain provisions based on actual experience.
In addition, we record revenue based on estimates of the earned portion of any
contract change orders not originally specified in the contract.
Specialty Product Revenues increased $14.8 million or 49.2%. Revenue increased
in the workers' compensation insurance segment by $15.2 million, which was
offset by a slight decrease in administrative services revenue of $.4 million.
Workers' compensation net earned premiums are the end result of direct written
premiums, plus the change in unearned premiums, less premiums ceded to
reinsurers. Direct written premiums decreased by 6.8% due primarily to a 29%
decrease in premium production that was partially offset by a 32% increase in
composite premium rates. Ceded reinsurance premiums decreased by 87% primarily
due to the expiration of our low level reinsurance agreement on June 30, 2000
and new lower cost reinsurance agreements.
Premiums in force are an indicator of future written premium trends. Inforce
premiums are the total estimated annual premiums of all policies in force at a
point in time. Total inforce premiums have decreased by 8.8% to $168.6 million
from the same period last year and have dropped by 11.4% from their peak in the
last twelve months, which was August 2000. This decrease indicates a slowing
trend in premiums written, especially in California, due largely to business
lost as a result of premium rate increases we have been obtaining. The number of
inforce policies at June 30, 2001 has also dropped by 21.8% from its peak in the
last twelve months, which was also August 2000.
As compared to the low level reinsurance agreement that expired on June 30,
2000, the new reinsurance agreements result in higher net earned premium
revenues, as we retain more of the premium dollars, but also lead to our keeping
more of the incurred losses. This resulted in a higher loss and loss adjustment
expense, or LAE, ratio as the percentage increase in the additional incurred
losses was greater than the percentage increase in the additional premiums
retained. The effect on the balance sheet will eventually result in a lower
amount of reinsurance recoverables and due to the length of time that it
typically takes to fully pay a claim, we should see an increase in operating
cash flow and amounts available to be invested.
Professional Fees decreased $1.9 million or 20.1% due primarily to the closing
of our affiliated medical groups in Texas and Arizona during 2000.
Investment and Other Revenues increased $.1 million or 1.1% due primarily to an
increase in the average invested balance during the period offset by a decrease
in the average investment yield.
Medical Expenses decreased $54.0 million or 21.9%. Medical expenses for 2001
include a $7.8 million reclassification from premium deficiency maintenance
reserve to premium deficiency medical reserve. See Note 2 to the condensed
consolidated financial statements for a discussion of this reclassification.
Included in medical expenses for 2000, are charges of $29.5 million of reserve
strengthening primarily for adverse development related to prior periods'
medical claims, $15.5 million of premium deficiency and $10.2 million of other
non-recurring medical costs. Excluding these items for both 2001 and 2000,
medical expenses decreased $6.5 million or 3.4% and the Medical Care Ratio
(medical expenses as a percentage of medical premiums and professional fees)
decreased from 83.6% to 81.9%. Excluding the items above and the premium
deficiency utilization of $4.9 million for 2001 and $8.5 million for 2000 the
Medical Care Ratio decreased from 87.3% to 84.0%. The improvement is primarily
due to the closing and sale of operations with higher medical care ratios in
Texas and rural Nevada and price increases in excess of cost increases.
Offsetting some of the improvements in the ratios was an increase in Medicare
members as a percentage of fully-insured members. The cost of providing medical
care to Medicare members generally requires a greater percentage of the premiums
received.
Military Contract Expenses increased $16.2 million or 23.1%. The increase is
consistent with the increase in revenues discussed previously. Military Contract
Expenses consist primarily of health care delivery expenses and administrative
service expenses and represent the costs to provide managed health care services
to eligible beneficiaries in accordance with Sierra's TRICARE contract. Under
the contract, Sierra Military Health Services, Inc., or SMHS, provides health
care services to approximately 642,300 dependents of active duty military
personnel and military retirees and their dependents under the age of 65 through
subcontractor partnerships and individual providers. Health care costs are
recorded in the period when services are provided to eligible beneficiaries,
including estimates for provider costs, which have been incurred but not
reported to us. Also, included in military contract expenses are costs incurred
to perform specific administrative services, such as health care appointment
scheduling, enrollment, network management and health care advice line services,
and other administrative functions of the military health care subsidiary. These
administrative services are performed for active duty personnel and family
members as well as retired military families.
Specialty Product Expenses decreased $1.3 million or 2.8%. Expenses decreased in
the workers' compensation insurance segment by $.8 million and administrative
services expense decreased by $.5 million.
The decrease in the workers' compensation insurance segment expenses is
primarily due to the following:
o Approximately $9.9 million in additional LAE related to the increase in net
earned premiums in 2001 compared to 2000.
o We established a higher LAE ratio for the 2001 accident year, which has
resulted in an increase of approximately $1.9 million. The majority of the
increase is due to the termination of the low level reinsurance agreement
on June 30, 2000, which results in a higher risk exposure on policies
effective after that date and a higher amount of net incurred LAE.
o In the second quarter of 2001, we recorded $4.2 million of net adverse loss
development for prior accident years, primarily for accident years 1996 to
1998, compared to net adverse loss development of $19.2 million recorded in
the second quarter of 2000, primarily for accident years 1996 to 1999. The
net adverse development recorded was largely attributable to higher costs
per claim, or claim severity, in California. Higher claim severity has had
a negative impact on the entire California workers' compensation industry.
o An increase in underwriting expenses, policyholders' dividends and other
operating expenses which resulted in an additional $2.4 million in
expenses.
The net adverse loss development on prior accident years included those years
that were covered by our low level reinsurance agreement. This resulted in an
increase, net of paid recoveries, in the amount of reinsurance recoverable of
$11.6 million in 2001 and $44.4 million in 2000.
Under our low level reinsurance agreement, we reinsure 30% of the first $10,000
of each claim, 75% of the next $40,000 and 100% of the next $450,000. The
maximum net loss retained on any one claim ceded under this agreement is
$17,000. This agreement covered all policies in force at July 1, 1998 and
continued until June 30, 2000, when we executed an option to extend coverage to
all policies in force as of June 30, 2000. For policies effective from July 1,
2000, we obtained excess of loss reinsurance for 100% of the losses above
$250,000 and less than $500,000. We already had an existing excess of loss
reinsurance agreement that covered 100% of the losses above $500,000. While the
low level reinsurance agreement is in run off effective July 1, 2000, our
California premium rates have been increasing, which we believe will largely
mitigate the loss of this favorable reinsurance protection. The premium rate
increases on policies renewed in California during the second quarter of 2001
were approximately 39%.
The combined ratio is a measurement of underwriting profit or loss and is the
sum of the loss and LAE ratio, underwriting expense ratio and policyholders'
dividend ratio. A combined ratio of less than 100% indicates an underwriting
profit. Our combined ratio was 103.9% compared to 164.8% for 2000. The decrease
was primarily due to significantly higher adverse development recorded during
2000. Excluding adverse loss development, the 6.0% decrease in the combined
ratio was primarily due to a decrease in the underwriting expense ratio as a
result of higher net earned premiums, which provide a larger base to spread
fixed costs.
General, Administrative and Marketing Expenses, or G&A, increased $2.9
million or 8.3%. As a percentage of revenues, G&A expenses were 10.3% for
both periods. As a percentage of medical premium revenue, G&A expenses were
17.2% compared to 15.8%. Excluding the utilization of premium deficiency
reserves for maintenance costs of $1.1 million for 2001 and $3.4 million for
2000, G&A expenses increased $.6 million or 1.4% for the period.
Restructuring, Reorganization and Other Costs were recorded in 2000 and $7.8
million was reallocated during the second quarter of 2001. See Notes 2 and 3 to
the condensed consolidated financial statements for further discussion.
Interest Expense and Other, Net decreased $.4 million or 7.7%, due primarily to
a decrease in the average balance of outstanding debt during the period which
was slightly offset by an increase in weighted average cost of borrowing. Our
average revolving credit facility balance was $63 million in 2001 compared to
$185 million in 2000. Our average interest rate on the revolving credit
facility, including the amortization of deferred financing fees, was 10.7% in
2001 compared to 9.7% in 2000. The decrease was offset by an increase in
interest expense of $2.4 million for interest expense related to the net
financing obligations associated with the sale-leaseback transaction that was
completed in December 2000 and a net loss on property and equipment disposition
of $2.4 million.
Provision for Income Taxes was recorded at $1.4 million compared to a benefit of
$77.6 million with an effective tax rate of 33.5% compared to 27.3% for 2000.
The effective tax rate for 2000 reflects the non-deductibility of certain
portions of goodwill impairment expense recorded during the period. Excluding
the effect of the goodwill impairment expense, the effective tax rate for both
periods was approximately 33.5%. Our ongoing effective tax rate is less than the
statutory rate due to tax preferred investments offset by state income taxes.
RESULTS OF OPERATIONS, SIX MONTHS ENDED JUNE 30, 2001, COMPARED TO SIX MONTHS
ENDED JUNE 30, 2000.
Total Operating Revenues for 2001 increased approximately 7.5% to $714 million
from $664 million for 2000.
The change in operating revenues was comprised of the following:
o A decrease in medical premiums of $7.8 million
o An increase in military contract revenues of $32.7 million
o An increase in specialty product revenues of $28.2 million
o A decrease in professional fees of $5.6 million
o An increase in investment and other revenues of $2.1 million
Medical premiums accounted for approximately 60.3% and 66.0% of our total
revenues for 2001 and 2000, respectively. The decrease in medical premiums as a
percentage of total revenues in 2001 is primarily due to the increase in
specialty product and military contract revenues and the decrease in premium
revenue due to the decrease in commercial HMO membership in Texas. Medical
premium revenue growth is principally dependent upon continued enrollment in our
products and upon competitive and regulatory factors.
Medical Premiums decreased $7.8 million or 1.8%. The decrease in premium revenue
reflects a 19.4% decrease in commercial member months (the number of months of
each year that an individual is enrolled in a plan) offset by a 7.0% increase in
Medicare member months. The decrease in commercial member months is primarily
related to the sale of our Houston HMO membership during the fourth quarter of
2000. Excluding the Texas operations, premium revenue increased by $20.1 million
or 6.3%, Medicare member months increased by 6.8% and commercial member months
remained flat. The growth in Medicare member months contributes significantly to
increases in premium revenues as the Medicare per member premium rates are over
three times higher than the average commercial premium rate. The average
commercial rate increases in 2001 on renewed groups are approximately 8% and 16%
in Las Vegas and Dallas/Ft. Worth, respectively. Our managed indemnity rates
increased approximately 11.1% and Medicare rates increased approximately 4.0%,
of which a portion is attributable to an increase in member benefits.
We market our HMO and managed indemnity insurance products primarily to employer
groups, labor unions and individuals enrolled in Medicare, through our internal
sales personnel and independent insurance brokers. Our brokers receive
commissions based on the premiums received from each group. Our agreements with
our member groups are usually for twelve months and are subject to annual
renewal. For the period ended June 30, 2001, our ten largest commercial HMO
employer groups were, in the aggregate, responsible for less than 10% of our
total revenues. Although none of the employer groups accounted for more than 2%
of total revenues for that period, the loss of one or more of the larger
employer groups could, if not replaced with similar membership, have a material
adverse effect on our business.
Military Contract Revenues increased $32.7 million or 23.9%. The increase in
revenue is the result of additive change order work. The revenue increase is
significantly offset by increased military contract expenses. The change orders
recently implemented include a prescription drug program for beneficiaries over
age 65 and the waiver of co-payments for active duty family members. Military
contract revenue is recorded based on the contract price as agreed to by the
federal government, adjusted for certain provisions based on actual experience.
In addition, we record revenue based on estimates of the earned portion of any
contract change orders not originally specified in the contract.
Specialty Product Revenues increased $28.2 million or 48.5%. Revenue increased
in the workers' compensation insurance segment by $29.0 million, which was
offset by a slight decrease in administrative services revenue of $.8 million.
Workers' compensation net earned premiums are the end result of direct written
premiums, plus the change in unearned premiums, less premiums ceded to
reinsurers. Direct written premiums decreased by 1% due primarily to a 25%
decrease in premium production that was partially offset by a 33% increase in
composite premium rates. Ceded reinsurance premiums decreased by 72% primarily
due to the expiration of our low level reinsurance agreement on June 30, 2000
and new lower cost reinsurance agreements.
As compared to the low level reinsurance agreement that expired on June 30,
2000, the new reinsurance agreements result in higher net earned premium
revenues, as we retain more of the premium dollars, but also lead to our keeping
more of the incurred losses. This resulted in a higher loss and loss adjustment
expense, or LAE, ratio as the percentage increase in the additional incurred
losses was greater than the percentage increase in the additional premiums
retained. The effect on the balance sheet will eventually result in a lower
amount of reinsurance recoverables and due to the length of time that it
typically takes to fully pay a claim, we should see an increase in operating
cash flow and amounts available to be invested.
Professional Fees decreased $5.6 million or 27.2% due primarily to the closing
of our affiliated medical groups in Texas and Arizona during 2000.
Investment and Other Revenues increased $2.1 million or 21.9%, due primarily to
an increase in the average invested balance during the period and net gains on
sale of investments of $.3 million in 2001 versus net losses on the sale of
investments of $.8 million in 2000.
Medical Expenses decreased $64.8 million or 14.8%. Medical expenses for 2001
include a $7.8 million reclassification from premium deficiency maintenance
reserve to premium deficiency medical reserve. See Note 2 to the condensed
consolidated financial statements for a discussion of this reclassification.
Included in medical expenses for 2000 are charges of $30.5 million for reserve
strengthening primarily for adverse development related to prior periods'
medical claims, $15.5 million of premium deficiency and $10.2 million of other
non-recurring medical costs. Excluding these items for both 2001 and 2000,
medical expenses decreased $16.4 million or 4.3% and the Medical Care Ratio
(medical expenses as a percentage of medical premiums and professional fees)
decreased from 83.4% to 82.3%. Excluding the items above and the premium
deficiency utilization of $7.0 million for 2001 and $14.8 million for 2000, the
Medical Care Ratio decreased from 86.7% to 83.9%. The improvement is primarily
due to the closing and sale of operations with higher medical care ratios in
Texas and rural Nevada and price increases in excess of cost increases.
Offsetting some of the improvements in the ratios was an increase in Medicare
members as a percentage of fully-insured members.
Military Contract Expenses increased $33.8 million or 25.4%. The increase is
consistent with the increase in revenues discussed previously. Health care
delivery expense consists primarily of costs to provide managed health care
services to eligible beneficiaries in accordance with Sierra's TRICARE contract.
Under the contract, SMHS, provides health care services to approximately 642,300
dependents of active duty military personnel and military retirees and their
dependents under the age of 65 through subcontractor partnerships and individual
providers. Health care costs are recorded in the period when services are
provided to eligible beneficiaries, including estimates for provider costs,
which have been incurred but not reported to us. Also, included in military
contract expenses are costs incurred to perform specific administrative
services, such as health care appointment scheduling, enrollment, network
management and health care advice line services, and other administrative
functions of the military health care subsidiary. These administrative services
are performed for active duty personnel and family members as well as retired
military families.
Specialty Product Expenses increased $15.7 million or 21.3%. Expenses increased
in the workers' compensation insurance segment by $16.7 million and
administrative services expense decreased by $1.0 million.
The increase in the workers' compensation insurance segment expenses is
primarily due to the following:
o Approximately $18.0 million in additional LAE related to the increase
in net earned premiums in 2001 compared to 2000.
o In 2001, we recorded $5.8 million of net adverse loss development for
prior accident years, primarily 1996 to 1998, compared to net adverse
loss development of $20.7 million recorded in 2000, primarily for
accident years 1996 to 1999. The net adverse development recorded was
largely attributable to higher costs per claim, or claim severity, in
California. Higher claim severity has had a negative impact on the
entire California workers' compensation industry.
o We established a higher LAE ratio for the 2001 accident year, which
has resulted in an increase of approximately $9.5 million. The
majority of the increase is due to the termination of the low level
reinsurance agreement on June 30, 2000, which results in a higher risk
exposure on policies effective after that date and a higher amount of
net incurred LAE.
o An increase in underwriting expenses, policyholders' dividends and
other operating expenses which resulted in an additional $4.1 million
in expenses.
The net adverse loss development on prior accident years included those
years that were covered by our low level reinsurance agreement. This
resulted in an increase, net of paid recoveries, in the amount of
reinsurance recoverable of $10.6 million in 2001 and $59.1 million in 2000.
Under our low level reinsurance agreement, we reinsure 30% of the first
$10,000 of each claim, 75% of the next $40,000 and 100% of the next
$450,000. The maximum net loss retained on any one claim ceded under this
agreement is $17,000. This agreement covered all policies in force at July
1, 1998 and continued until June 30, 2000, when we executed an option to
extend coverage to all policies in force as of June 30, 2000. For policies
effective from July 1, 2000, we obtained excess of loss reinsurance for
100% of the losses above $250,000 and less than $500,000. We already had an
existing excess of loss reinsurance agreement that covered 100% of the
losses above $500,000. While the low level reinsurance agreement is in run
off effective July 1, 2000, our California premium rates have been
increasing, which we believe will largely mitigate the loss of this
favorable reinsurance protection. The premium rate increases on policies
renewed in California during the first six months of 2001 were
approximately 41%.
The combined ratio is a measurement of underwriting profit or loss and is
the sum of the loss and LAE ratio, underwriting expense ratio and
policyholders' dividend ratio. A combined ratio of less than 100% indicates
an underwriting profit. Our combined ratio was 106.3% compared to 132.9%
for 2000. The decrease was primarily due to significantly higher adverse
development recorded during 2000. Excluding adverse loss development, the
increase in the loss and LAE ratio was primarily due to the run off of the
low level reinsurance which is resulting in our retaining more of the
incurred losses. The underwriting expense ratio decreased primarily due to
higher retained net earned premiums.
General, Administrative and Marketing Expenses, or G&A, increased $2.2
million or 3.2%. As a percentage of revenues, G&A expenses for 2001
were 10.0% compared to 10.4% for 2000. As a percentage of medical premium
revenue, G&A expenses were 16.5% compared to 15.7%. Excluding the
utilization of premium deficiency reserves for maintenance costs of $1.3
million for 2001 and $9.0 million for 2000, G&A expenses decreased $5.5
million or 7.0% for the period. The $5.5 million decrease was primarily
attributable to a $3.2 million decrease in payroll costs and a $3.5 million
decrease in depreciation and amortization expense due to the write down of
certain fixed assets and the write-off of unamortized goodwill during 2000
offset by various other cost increases and decreases. Much of the salary
savings is due to cost saving initiatives consisting of the restructuring
of our Texas HMO operations by consolidating certain functions with our
existing operations in Las Vegas and corporate expense reductions.
Restructuring, Reorganization and Other Costs were recorded in 2000 and
$7.8 million was reallocated during the second quarter of 2001. See Notes 2
and 3 to the condensed consolidated financial statements for further
discussion.
Interest Expense and Other, Net remained consistent for both periods.
Interest expense related to the revolving credit facility decreased $4.4
million due to a decrease in the average balance of outstanding debt during
the period offset by an increase in weighted average cost of borrowing. Our
average revolving credit facility balance was $78 million in 2001 compared
to $182 million in 2000. Our average interest rate on the revolving credit
facility, including the amortization of deferred financing fees, was 10.3%
in 2001 compared to 9.2% in 2000. The decrease was offset by an increase in
interest expense of $4.8 million for interest expense related to the net
financing obligations associated with the sale-leaseback transaction that
was completed in December 2000.
Provision for Income Taxes was recorded at $3.0 million compared to a
benefit of $76.8 million with an effective tax rate of 33.5% compared to
27.2% for 2000. The effective tax rate for 2000 reflects the
non-deductibility of certain portions of goodwill impairment expense
recorded during the period. Excluding the effect of the goodwill impairment
expense, the effective tax rate for both periods was approximately 33.5%.
Our ongoing effective tax rate is less than the statutory rate due to tax
preferred investments offset by state income taxes.
LIQUIDITY AND CAPITAL RESOURCES
We had cash in-flows from operating activities of $39.6 million for the six
months ended June 30, 2001 compared to cash out-flows of $20.0 million for
2000. The improvement over 2000 is primarily attributable to cash from
earnings and collections from outstanding military accounts receivable and
other accounts receivable.
SMHS receives monthly cash payments equivalent to one-twelfth of its annual
contractual price with the Department of Defense, or DoD. SMHS accrues
health care revenue on a monthly basis for any monies owed above its
monthly cash receipt based on the number of at-risk eligible beneficiaries
and the level of military direct care system utilization. The contractual
bid price adjustment, or BPA, process serves to adjust the DoD's monthly
payments to SMHS, because the payments are based in part on prospective
data estimates for the beneficiary population and beneficiary population
baseline health care cost, inflation and military direct care system
utilization. As actual information becomes available for the above items,
quarterly adjustments are made to SMHS' monthly health care payment in
addition to lump sum adjustments for past months. In addition, SMHS accrues
change order revenue for DoD directed contract changes. During January
2001, SMHS reached an agreement with the DoD on a settlement of $58.2
million related to contract modifications issued prior to July 1, 2000.
SMHS received an immediate payment of $21.3 million for outstanding
receivables and will receive an additional $1.1 million per month until the
end of the contract. Our business and cash flows could be adversely
affected if the timing or amount of the BPA and change order reimbursements
vary significantly from our expectations. SMHS is in the process of
finalizing a financing arrangement on its accounts receivable balance in
order to improve the availability of cash. The military accounts receivable
balance was $40.4 million as of June 30, 2001.
Cash used for investing activities during 2001 included $3.8 million in
capital expenditures offset by proceeds of $1.7 million for property and
equipment dispositions. The net cash change in investments for the period
was $6.4 million as investments were purchased with cash from operations.
Cash used for financing activities included net payments of $36 million on
the revolving credit facility, $21.5 million for the purchase of 7 1/2%
convertible subordinated debentures and an additional $4.1 million in
payments on other outstanding debt and capital leases.
Revolving Credit Facility
Our revolving credit facility balance decreased from $135 million to $99
million during the six month period. The entire balance outstanding is
reflected as long-term debt since we are not required to make any further
payments during the next twelve months. The revolving credit facility
commitment was $123.4 million as of June 30, 2001 and will decrease by $3.0
million on December 31, 2001 and an additional $6.0 million on June 30,
2002. Interest under the revolving credit facility is variable and is based
on Bank of America's "prime rate" plus a margin. The rate was 7.875% at
June 30, 2001, which is a combination of the prime rate of 7.25% plus a
margin of .625%. The margin can fluctuate in the future based on our
completing certain transactions and meeting certain financial ratios. To
mitigate the risk of interest rate fluctuation on the revolving credit
facility, of the outstanding balance, $25 million is covered by an
interest-rate swap agreement. The average cost of borrowing on this
revolving credit facility for 2001, including the impact of the
amortization of deferred financing fees and the interest-rate swap
agreement, was 10.3%.
Debentures
In September 1991, CII Financial, Inc., or CII, our workers' compensation
holding company, issued 7 1/2% convertible subordinated debentures. CII
anticipated that they would not have readily available sources of cash to
pay the 7 1/2% convertible subordinated debentures when they were scheduled
to mature in September 2001 and initiated a proposed exchange offer in
December 2000. CII offered to exchange the new debentures and/or cash for
the 7 1/2% convertible subordinated debentures. To facilitate the exchange,
CII borrowed $17.0 million from Sierra and California Indemnity, one of
CII's insurance subsidiaries, was able to obtain approval from the
California Department of Insurance to pay an extraordinary dividend of $5.0
million to CII. On May 7, 2001, CII closed its exchange offer on
approximately $42.1 million of its outstanding 7 1/2% convertible
subordinated debentures. CII purchased approximately $27.1 million in
principal amount of 7 1/2% convertible subordinated debentures for
approximately $20.0 million in cash and issued approximately $15.0 million
in new 9 1/2% senior debentures, due September 15, 2004, in exchange for
approximately $15.0 million in 7 1/2% convertible subordinated debentures.
CII has approximately $5.0 million in 7 1/2% convertible subordinated
debentures due September 15, 2001. Interest on the 7 1/2% convertible
subordinated debentures is due semi-annually on March 15 and September 15.
Each $1,000 in principal is convertible into 25.382 shares of common stock
of Sierra at a conversion price of $39.398 per share.
The new 9 1/2% senior debentures pay interest, which is due semi-annually
on March 15 and September 15 of each year commencing on September 15, 2001.
The new 9 1/2% senior debentures rank senior to the outstanding notes
payable from CII to Sierra, the remaining 7 1/2% convertible subordinated
debentures and CII's guarantee of Sierra's revolving credit facility. The
new 9 1/2% senior debentures may be redeemed by CII at any time at defined
premiums starting at 110% and declining to 100% for purchases after April
1, 2004. In the event of a change in control of CII, the holders of these
new 9 1/2% senior debentures may require that we repurchase them at the
then applicable redemption price, plus accrued and unpaid interest.
CII's only significant short-term non-insurance liquidity need is for
interest on the debentures and the repayment of the approximately $5.0
million in outstanding 7 1/2% convertible subordinated debentures, which is
due on September 15, 2001 as discussed above. CII's new 9 1/2% senior
debentures represent the long-term non-insurance liquidity requirements.
CII expects to service the new 9 1/2% senior debentures from future cash
flows, primarily from dividends that will be paid by their insurance
subsidiaries from their future earnings. CII is exploring alternatives to
address the maturity of the approximately $5.0 million in 7 1/2%
convertible subordinated debentures that are due September 15, 2001.
Statutory Capital and Deposit Requirements
Our HMO and insurance subsidiaries are required by state regulatory
agencies to maintain certain deposits and must also meet certain net worth
and reserve requirements. The HMO and insurance subsidiaries had restricted
assets on deposit in various states totaling $26.4 million at June 30,
2001. The HMO and insurance subsidiaries must also meet requirements to
maintain minimum stockholders' equity, on a statutory basis, as well as
minimum risk-based capital requirements, which are determined annually.
Additionally, in conjunction with the Kaiser-Texas acquisition, Texas
Health Choice, L.C., or TXHC, entered into a letter agreement with the
Texas Department of Insurance whereby TXHC agreed to maintain a net worth
of $20.0 million, on a statutory basis, until certain income levels are
achieved. We believe we are in compliance with our regulatory requirements
in all material respects.
Of the $131.4 million in cash and cash equivalents held at June 30, 2001,
$100.1 million was designated for use only by the regulated subsidiaries.
Amounts are available for transfer to the holding company from the HMO and
insurance subsidiaries only to the extent that they can be remitted in
accordance with the terms of existing management agreements or by
dividends. The holding company will not receive dividends from its
regulated subsidiaries if such dividend payment would cause violation of
statutory net worth and reserve requirements.
Other
We have a 2001 capital budget of $18 million as limited by our revolving
credit facility. The planned expenditures are primarily for the expansion
of clinics and other leased facilities, the purchase of computer hardware
and software, furniture and equipment and other normal capital
requirements. Our liquidity needs over the next 12 months will primarily be
for the capital items noted above, expansion of our operations and debt
service, including the remaining $5.0 million of 7 1/2% convertible
subordinated debentures due September 15, 2001. We believe that our
existing working capital, operating cash flow and, if necessary, cash flow
from equipment leasing, divestitures of certain non-core assets and amounts
available under our revolving credit facility should be sufficient to fund
our capital expenditures and debt service. Additionally, subject to
unanticipated cash requirements, we believe that our existing working
capital and operating cash flow should enable us to meet our liquidity
needs on a long-term basis.
Membership
Our membership at June 30, 2001 and 2000 was as follows:
Number of Members at June 30
2001 2000
HMO
Commercial (1).............................................. 198,800 250,700
Medicare (2) (3)........................................... 57,800 53,100
Medicaid.................................................... 19,000 12,200
Managed Indemnity............................................. 29,700 32,900
Medicare Supplement........................................... 28,100 28,700
Administrative Services....................................... 298,400 278,100
TRICARE Eligibles............................................. 642,300 613,500
--------- ----------
Total Members................................................. 1,274,100 1,269,200
========= =========
(1) The number of commercial members at June 30, 2000 includes 23,100 members
associated with the discontinued operations in Houston, Texas.
(2) The number of Medicare members at June 30, 2000 includes 5,500 members
associated with the discontinued operations in Houston, Texas.
(3) The 2001 Medicare membership does not include 5,500 Houston members that
the Company ceded to AmCare Health Plans of Texas, Inc. under a reinsurance
agreement on December 1, 2000.
SIERRA HEALTH SERVICES, INC. AND SUBSIDAIRES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of June 30, 2001, unrealized holding losses on available for sale investments
have increased by $1,589,000 since the 2000 year end due primarily to a decrease
in the market value of bonds. We believe that changes in market interest rates,
resulting in unrealized holding gains or losses, should not have a material
impact on future earnings or cash flows as it is unlikely that we would need or
choose to substantially liquidate our investment portfolio.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are subject to various claims and other litigation in the ordinary course of
business. Such litigation includes claims of medical malpractice, claims for
coverage or payment for medical services rendered to HMO members and claims by
providers for payment for medical services rendered to HMO members. Also
included in such litigation are claims for workers' compensation and claims by
providers for payment for medical services rendered to injured workers. In the
opinion of management, the ultimate resolution of these pending legal
proceedings should not have a material adverse effect on our financial
condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Sierra held its annual meeting of stockholders on May 22, 2001 in Las
Vegas, Nevada.
The following persons were elected directors for two-year terms
ending in 2003 based on the voting results below:
Name For Withheld
Anthony M. Marlon, M.D. 19,798,224 5,949,322
Thomas Y. Hartley 23,348,255 2,399,291
Anthony L. Watson 23,344,629 2,402,917
Michael E. Luce 23,345,165 2,402,381
The following persons were elected to one-year terms ending
in 2002 based on the voting results below:
Name For Withheld
Albert L. Greene 23,344,082 2,403,464
Erin E. MacDonald 19,777,466 5,970,080
The following persons' terms as directors continued after the
meeting and end in 2002.
Charles L. Ruthe
William J. Raggio
The stockholders also approved an amendment to the Company's
Bylaws to increase the size of the Board from a range of not less
than three nor more than seven Directors to a range of not less
than three nor more than nine Directors.
Broker
For Against Abstain Non-votes
16,165,817 2,236,963 13,120 0
The stockholders also ratified the appointment of Deloitte &
Touche LLP as the Company's independent auditors for the year
ending December 31, 2001. The voting results were as follows:
Broker
For Against Abstain Non-votes
25,610,289 180,497 9,954 0
The stockholders also voted on a shareholder proposal. The voting
results were as follows:
Broker
For Against Abstain Non-votes
7,829,421 10,240,080 346,399 0
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(10.1) Employment Agreement with Erin E. MacDonald executed June
1, 2001.
(99) Registrant's current report on Form 8-K dated March
20, 2001, incorporated herein by reference.
(b) Reports on Form 8-K
Current Report on Form 8-K, dated May 8, 2001, with the
Securities and Exchange Commission in connection with the
announcement of the Company's participation in a health care
conference on May 10, 2001 and the Company's hosting of an
investor conference on May 14, 2001.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SIERRA HEALTH SERVICES, INC.
(Registrant)
Date: August 14, 2001 /S/ PAUL H. PALMER
Paul H. Palmer
Vice President of Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)