UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 November 1, 2001, there were 27,880,000 shares of common
stock outstanding.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
FORM 10-Q FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001
INDEX
Page No.
Part I - FINANCIAL INFORMATION
Item l. Financial Statements
Condensed Consolidated Balance Sheets -
September 30, 2001 and December 31, 2000................................................. 3
Condensed Consolidated Statements of Operations -
three and nine months ended September 30, 2001 and 2000.................................. 4
Condensed Consolidated Statements of Cash Flows -
nine months ended September 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.......................................................................... 24
Item 6. Exhibits and Reports on Form 8-K........................................................... 24
Signatures................................................................................................... 25
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
September 30 December 31
2001 2000
(Unaudited)
CURRENT ASSETS:
Cash and Cash Equivalents.............................................. $ 159,734 $ 161,306
Investments............................................................ 214,411 207,143
Accounts Receivable (Less Allowance for Doubtful
Accounts: 2001 - $15,955; 2000 - $17,996).......................... 28,256 33,094
Military Accounts Receivable (Less Allowance for Doubtful
Accounts: 2001 - $1,316; 2000 - $1,212)............................ 34,723 71,390
Current Portion of Deferred Tax Asset.................................. 49,320 46,702
Current Portion of Reinsurance Recoverable............................. 91,511 92,867
Prepaid Expenses and Other Current Assets.............................. 44,396 33,559
Assets Held for Sale................................................... 19,484 22,942
---------- ----------
Total Current Assets............................................... 641,835 669,003
PROPERTY AND EQUIPMENT, NET................................................. 147,645 173,031
LONG-TERM INVESTMENTS....................................................... 9,277 18,093
RESTRICTED CASH AND INVESTMENTS............................................. 26,122 24,724
REINSURANCE RECOVERABLE, Net of Current Portion............................. 171,074 160,227
DEFERRED TAX ASSET, Net of Current Portion.................................. 63,329 68,253
OTHER ASSETS................................................................ 56,918 51,769
---------- ----------
TOTAL ASSETS................................................................ $1,116,200 $1,165,100
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts Payable and Accrued Liabilities.................................. $ 92,986 $ 109,696
Medical Claims Payable.................................................... 111,669 112,296
Current Portion of Reserve for Losses and Loss Adjustment Expense......... 147,351 134,676
Unearned Premium Revenue.................................................. 61,200 48,373
Military Health Care Payable.............................................. 85,239 84,859
Premium Deficiency Reserve................................................ 9,788 14,466
Current Portion of Long-term Debt......................................... 36,617 88,223
---------- ----------
Total Current Liabilities.......................................... 544,850 592,589
RESERVE FOR LOSSES AND
LOSS ADJUSTMENT EXPENSE, Net of Current Portion........................... 263,258 239,878
LONG-TERM DEBT, Net of Current Portion...................................... 194,455 225,355
OTHER LIABILITIES .......................................................... 19,348 16,805
---------- ----------
TOTAL LIABILITIES........................................................... 1,021,911 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 - 29,403; 2000 - 28,815...... 147 144
Additional Paid-in Capital................................................ 179,670 177,493
Treasury Stock; 2001 and 2000 - 1,523 Common Stock Shares................. (22,789) (22,789)
Accumulated Other Comprehensive Loss...................................... (2,477) (5,667)
Accumulated Deficit....................................................... (60,262) (58,708)
---------- ----------
Total Stockholders' Equity......................................... 94,289 90,473
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................. $1,116,200 $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 Nine Months Ended
September 30 September 30
2001 2000 2001 2000
OPERATING REVENUES:
Medical Premiums.................................. $229,861 $221,669 $ 660,443 $ 660,098
Military Contract Revenues........................ 85,499 101,259 255,497 238,514
Specialty Product Revenues........................ 49,447 40,766 135,774 98,880
Professional Fees................................. 6,981 8,222 22,056 28,938
Investment and Other Revenues..................... 4,540 5,566 16,383 15,282
-------- -------- ---------- ----------
Total....................................... 376,328 377,482 1,090,153 1,041,712
-------- -------- ---------- ----------
OPERATING EXPENSES:
Medical Expenses (Note 2)......................... 205,349 191,566 579,854 630,873
Military Contract Expenses........................ 83,561 99,889 250,332 232,872
Specialty Product Expenses........................ 50,144 41,671 139,570 115,403
General, Administrative and Marketing
Expenses........................................ 38,233 34,327 109,432 103,312
Asset Impairment, Restructuring, Reorganization
and Other Costs (Notes 2 and 3)................. 6,585 (1,215) 220,440
-------- -------- ---------- ----------
Total ...................................... 383,872 367,453 1,077,973 1,302,900
-------- -------- ---------- ----------
OPERATING (LOSS) INCOME.............................. (7,544) 10,029 12,180 (261,188)
INTEREST EXPENSE AND OTHER, NET .................... (3,814) (6,091) (14,516) (16,828)
-------- -------- ---------- ----------
(LOSS) INCOME BEFORE INCOME TAXES.................... (11,358) 3,938 (2,336) (278,016)
BENEFIT (PROVISION) FOR INCOME TAXES................. 3,804 (1,269) 782 75,524
-------- -------- ---------- ----------
NET (LOSS) INCOME.................................... $ (7,554) $ 2,669 $ (1,554) $ (202,492)
======== ======== ========== ==========
NET (LOSS) INCOME PER COMMON SHARE................... $(.27) $.10 $(.06) $(7.47)
===== ==== ===== ======
NET (LOSS) INCOME PER COMMON SHARE
ASSUMING DILUTION................................. $(.27) $.10 $(.06) $(7.47)
===== ==== ===== ======
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING....................................... 27,851 27,248 27,619 27,092
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING ASSUMING DILUTION..................... 27,851 27,250 27,619 27,092
See accompanying notes to condensed consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended September 30
2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss................................................................ $ (1,554) $(202,492)
Adjustments to Reconcile Net Loss to Net Cash
Provided by (Used for) Operating Activities:
Provision for Asset Impairment and Other Charges................. 2,325 202,951
Depreciation and Amortization.................................... 18,811 23,588
Provision for Doubtful Accounts.................................. 1,869 3,032
Loss on Property and Equipment Dispositions...................... 2,399
Changes in Assets and Liabilities....................................... 48,829 (57,628)
-------- ---------
Net Cash Provided by (Used for) Operating Activities ........ 72,679 (30,549)
-------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures, Net of Dispositions............................... 6,640 (13,615)
Changes in Investments.................................................. (565) 23,439
-------- ---------
Net Cash Provided by Investing Activities.................... 6,075 9,824
-------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Borrowings................................................ 25,000
Payments on Debt and Capital Leases..................................... (82,506) (7,036)
Issuance of Stock in Connection with Stock Plans........................ 2,180 1,572
-------- ---------
Net Cash (Used for) Provided by Financing Activities......... (80,326) 19,536
-------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS.................................. (1,572) (1,189)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD........................... 161,306 55,936
-------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD................................. $159,734 $ 54,747
======== =========
Nine Months Ended September 30
Supplemental Condensed Consolidated
Statements of Cash Flows Information: 2001 2000
---------------------------------------------------------------------------
Cash Paid During the Period for Interest
(Net of Amount Capitalized)............................................. $16,468 $19,511
Net Cash Paid (Received) During the Period for Income Taxes................ 376 (10,538)
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
Included in reported medical expenses for 2000 are changes in estimate
charges of $30.5 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 costs after restructuring and reorganization actions.
In addition, the Company recorded $10.2 million of other non-recurring
medical costs primarily relating to the write-down of medical subsidiary
assets.
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 late in the second quarter of 2001, and
is reflected as an increase in medical expense and a decrease in asset
impairment, restructuring, reorganization and other costs on the condensed
consolidated statement of operations.
Throughout 2001, the Company has continued to focus on making the
Dallas/Ft. Worth operations profitable. Significant premium rate increases
have been made on renewing membership and during the third quarter the
Company embarked on a recontracting effort to reduce medical costs. It was
during this recontracting effort that unsustainable cost increases were
identified, including the fact that the operations' primary hospital
contract if renewed, would be at a substantially higher rate than was
previously indicated by the hospital.
Although considerable efforts had been made to achieve profitability in
Texas, it was determined that under the current operating environment, the
Company would not be able to turn around the operating results and the best
course of action was to exit the market as soon as possible to limit future
losses and exposure. During the third quarter of 2001, the Company
announced its plan to exit the Texas market and received formal approval
from the Texas Department of Insurance to withdraw its healthcare
operations in mid-October. The Company has also received a waiver under its
revolving credit facility agreement for all covenants affected by exiting
the Texas healthcare market.
As a result of the plan to exit the Texas healthcare market, the Company
recorded medical expense charges of $10.9 million and asset impairment,
restructuring, reorganization and other costs charges of $6.6 million. Of
the $10.9 million in medical expense charges, $10.3 million was for premium
deficiency medical and $600,000 was for the write down of a medical related
receivable. The $6.6 million charge consisted of $1.6 million to write down
certain Texas furniture and equipment, $2.0 million in lease and other
termination costs, $1.8 million in legal and restitution costs, $600,000 in
various other exit related costs and $570,000 in premium deficiency
maintenance. The total premium deficiency recorded of $10.9 million
represents the projected premium shortfall during the run-out of the Texas
healthcare operations and additional reserve strengthening for prior
periods.
The total premium deficiency medical reserve utilized during the three and
nine month periods ended September 30, 2001 was $7.1 million and $14.1
million, respectively. Management believes that the total premium
deficiency reserve of $9.8 million, as of September 30, 2001, is
appropriate based on the projected run-out of the Texas healthcare
operations and that no revision to the estimate is necessary at this time.
Of the $9.8 million remaining reserve, $9.2 million has been designated as
a premium deficiency medical reserve.
3. Asset Impairment, Restructuring, Reorganization and Other Costs
As discussed in Note 2 of these 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.
As part of the Company's plan to exit Texas, as discussed in Note 2 of
these financial statements, the Company recorded $1.6 million to write down
certain Texas furniture and equipment, $2.0 million in lease and other
termination costs, $1.8 million in legal and restitution costs, $600,000 in
various other exit related costs and $570,000 in premium deficiency
maintenance.
The table below presents a summary of asset impairment, restructuring,
reorganization and other cost activity 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................... 1,600 4,415 570 6,585
Cash used.......................... (2,446) (1,478) (800) (4,724)
Noncash activity................... (1,600) (125) (1,725)
Changes in estimate................ (7,800) (7,800)
-------- -------- --------- -------- ---------
Balance, September 30, 2001........ $ - $ 6,193 $ 570 $ 4,447 $ 11,210
======== ======== ========= ======== =========
Of the remaining restructuring and reorganization costs of $6.2 million,
$4.3 million is related to the charges incurred in the third quarter of
2001 as described above, and $1.9 million remains from the December 31,
2000 balance and is primarily related to the cost to provide malpractice
insurance on our discontinued affiliated medical group and lease
terminations in Houston and Arizona. The remaining premium deficiency
maintenance costs of $570,000 is an estimate of general and administrative
costs, in excess of those covered by premiums, that the Company expects to
be incurred during the run-out of the Texas healthcare operations. The
remaining other costs of $4.4 million are primarily related to legal
claims. Management believes that the remaining reserves, as of September
30, 2001, are appropriate and that no 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 September 30, 2001:
Loss from Continuing Operations $ (7,554) $ (7,554)
Shares 27,851 27,851
Per Share Amount $(.27) $(.27)
For the Three Months ended September 30, 2000:
Income from Continuing Operations $ 2,669 $ 2,669
Shares 27,248 2 27,250
Per Share Amount $.10 $.10
For the Nine Months ended September 30, 2001:
Loss from Continuing Operations $ (1,554) $ (1,554)
Shares 27,619 27,619
Per Share Amount $(.06) $(.06)
For the Nine Months ended September 30, 2000:
Loss from Continuing Operations $(202,492) $(202,492)
Shares 27,092 27,092
Per Share Amount $(7.47) $(7.47)
Outstanding stock options were not included in the computation of
diluted EPS for the three months and nine months ended September 30,
2001 and the nine months ended September 30, 2000 because their effect
would have been antidilutive.
5. The following table presents comprehensive income for the periods
indicated:
Three Months Ended Nine Months Ended
September 30 September 30
(In thousands) 2001 2000 2001 2000
NET (LOSS) INCOME........................... $(7,554) $2,669 $(1,554) $(202,492)
Change in Accumulated Other
Comprehensive Income, Net................. 4,779 921 3,190 4,771
------- ------ ------- ---------
COMPREHENSIVE (LOSS) INCOME................. $(2,775) $3,590 $ 1,636 $(197,721)
======= ====== ======= =========
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 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 September 30, 2001
Medical Premiums............................. $ 229,861 $ 229,861
Military Contract Revenues................... $ 85,499 85,499
Specialty Product Revenues................... 1,908 $ 47,539 49,447
Professional Fees............................ 6,981 6,981
Investment and Other Revenues................ 311 659 3,570 4,540
--------- -------- -------- ----------
Total Revenue............................. $ 239,061 $ 86,158 $ 51,109 $ 376,328
========= ======== ======== ==========
Segment Operating Profit (1)................. $6,086 $ 2,597 $ 1,273 $9,956
Interest Expense and Other, Net.............. (3,338) 31 (507) (3,814)
Changes in Estimate Charges (2).............. (10,915) (10,915)
Asset Impairment, Restructuring,
Reorganization and Other Costs.......... (6,585) (6,585)
--------- -------- -------- ----------
Net (Loss) Income Before Income Taxes........ $ (14,752) $ 2,628 $ 766 $ (11,358)
========= ======== ======== ==========
Three Months Ended September 30, 2000
Medical Premiums............................. $ 221,669 $ 221,669
Military Contract Revenues................... $101,259 101,259
Specialty Product Revenues................... 2,166 $ 38,600 40,766
Professional Fees............................ 8,222 8,222
Investment and Other Revenues................ 1,584 147 3,835 5,566
--------- -------- -------- ----------
Total Revenue............................. $ 233,641 $101,406 $ 42,435 $ 377,482
========= ======== ======== ==========
Segment Operating Profit (1)................. $ 6,182 $ 1,518 $ 2,329 $ 10,029
Interest Expense and Other, Net.............. (5,311) (74) (706) (6,091)
Changes in Estimate Charges (2)..............
Asset Impairment, Restructuring,
Reorganization and Other Costs..........
--------- -------- -------- -----------
Net Income Before Income Taxes............... $ 871 $ 1,444 $ 1,623 $ 3,938
========= ======== ======== ==========
Nine Months Ended September 30, 2001
Medical Premiums............................. $ 660,443 $660,443
Military Contract Revenues................... $255,497 255,497
Specialty Product Revenues................... 5,813 $129,961 135,774
Professional Fees............................ 22,056 22,056
Investment and Other Revenues................ 2,615 1,821 11,947 16,383
--------- -------- -------- ----------
Total Revenue............................. $ 690,927 $257,318 $141,908 $1,090,153
========= ======== ======== ==========
Segment Operating Profit (1)................. $ 17,718 $6,986 $ 4,976 $29,680
Interest Expense and Other, Net.............. (13,260) 14 (1,270) (14,516)
Changes in Estimate Charges (2).............. (18,715) (18,715)
Asset Impairment, Restructuring,
Reorganization and Other Costs.......... 1,215 1,215
--------- -------- -------- ----------
Net (Loss) Income Before Income Taxes........ $ (13,042) $ 7,000 $ 3,706 $ (2,336)
========= ======== ======== ==========
Nine Months Ended September 30, 2000
Medical Premiums............................. $ 660,098 $660,098
Military Contract Revenues................... $238,514 238,514
Specialty Product Revenues................... 6,858 $ 92,022 98,880
Professional Fees............................ 28,938 28,938
Investment and Other Revenues................ 3,880 601 10,801 15,282
--------- -------- ---------- ----------
Total Revenue............................. $ 699,774 $239,115 $102,823 $1,041,712
========= ======== ======== ==========
Segment Operating Profit (1)................. $ 16,981 $ 6,245 $ 8,823 $ 32,049
Interest Expense and Other, Net.............. (14,713) (439) (1,676) (16,828)
Changes in Estimate Charges (2).............. (56,297) (16,500) (72,797)
Asset Impairment, Restructuring,
Reorganization and Other Costs.......... (217,440) (3,000) (220,440)
--------- -------- ----------- ----------
Net (Loss) Income Before Income Taxes........ $(271,469) $ 5,806 $ (12,353) $ (278,016)
========= ======== ========= ==========
(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 approximately $47.1 million of Subordinated
Debentures outstanding that were 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 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.
The exchange offer contained 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 was 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 was 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
were less than the balance of the Subordinated Debentures at the time of
the exchange less the cash consideration given in the exchange.
Accordingly, 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 therefore no future
interest expense will be recognized for the debentures. The transaction
resulted in a gain of $613,000.
In September 2001, the California Department of Insurance gave approval to
California Indemnity, one of CII Financial's insurance subsidiaries, to pay
a dividend of $5.0 million to CII Financial. CII Financial used these funds
to pay the remaining $5.0 million in Subordinated Debentures at maturity.
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 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 the 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 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. In addition, the pronouncement
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 September 30, 2001 was $15.0 million and goodwill amortization
in the nine months ended September 30, 2001 was $606,000 and would have
been approximately the same amount in 2002 under current accounting
standards. The Company is currently considering the other provisions of the
pronouncement, but has not yet determined the impact on its financial
position and results of operations.
In October 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144"), which is effective January 1, 2002. SFAS No. 144
requires that long-lived assets that are to be sold within one year must be
separately identified and carried at the lower of carrying value or fair
value less costs to sell. Long-lived assets expected to be held longer than
one year are subject to depreciation and must be written down to fair value
upon impairment. Long-lived assets no longer expected to be sold within one
year, such as foreclosed real estate, must be written down to the lower of
current fair value or fair value at the date of foreclosure adjusted to
reflect depreciation since acquisition. The Company has not determined the
effect of implementing this standard.
9. Reclassifications
Certain amounts in the Condensed Consolidated Financial Statements for the
three and nine months ended September 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 SEPTEMBER 30, 2001, COMPARED TO THREE
MONTHS ENDED SEPTEMBER 30, 2000.
Medical Premiums increased $8.2 million or 3.7%. The increase in premium revenue
reflects a 10.2% decrease in commercial member months (the number of months of
each year that an individual is enrolled in a plan) offset by an 11.2% increase
in Medicare member months. The decrease in commercial member months is related
to the sale of our Houston HMO membership during the fourth quarter of 2000 and
a decrease in the Dallas/Ft. Worth membership. Excluding the Texas operations,
premium revenue increased by $24.1 million or 15.0%, commercial member months
increased by 15.4% and Medicare member months increased by 9.3%. 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% in Las Vegas. Our managed
indemnity rates increased approximately 11.2% and Medicare rates increased
approximately 3.7%, of which a portion is attributable to additional 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 September 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 decreased $15.8 million or 15.6%. The decrease in
revenue in 2001 is the result of accrued bid price adjustment revenue during
2000 which resulted from a true-up of prior periods' information received from
the government and was largely offset by accrued military contract expenses. The
accrued bid price adjustment revenue from 2000 was partially offset by additive
change order work during 2001. Change orders recently implemented in 2001
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.
SIERRA HEALTH SERVICES, INC. AND SUBSIDAIRES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Specialty Product Revenues increased $8.7 million or 21.3%. Revenue increased in
the workers' compensation insurance segment by $9.0 million, which was offset by
a slight decrease in administrative services revenue of $.3 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 15.9% due primarily to a 31%
decrease in premium production that was partially offset by a 27% increase in
composite premium rates. Ceded reinsurance premiums decreased by 94% due to the
expiration of our low level reinsurance agreement on June 30, 2000 and new lower
retention 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 12.7% to $165.6 million
compared to last year. This has resulted in a decrease in direct written
premiums, especially in California, which we believe is due largely to business
lost as a result of premium rate increases we have been attempting to receive.
The number of inforce policies at September 30, 2001 has also dropped by 25.2%
from the same period last year.
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 of the new reinsurance agreements
compared to the low level agreements 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 future operating cash flow
and amounts available to be invested.
Professional Fees decreased $1.2 million or 15.1% due primarily to the closing
of our affiliated medical groups in Texas and Arizona during 2000 and decreased
fee for service revenue in Las Vegas.
Investment and Other Revenues decreased $1.0 million or 18.4% due primarily to a
decrease in the average investment yield offset by an increase in the average
invested balance during the period.
Medical Expenses increased $13.8 million or 7.2%. Medical expenses for 2001
include charges of $10.3 million for premium deficiency medical and $600,000 for
the write down of a medical related receivable. See Note 2 to the Condensed
Consolidated Financial Statements for a discussion of these charges. Excluding
these items for 2001, medical expenses increased $2.9 million or 1.5% and the
Medical Care Ratio (medical expenses as a percentage of medical premiums and
professional fees) decreased from 83.3% to 82.1%. Excluding the items above and
the premium deficiency utilization of $7.1 million for 2001 and $1.6 million for
2000, the Medical Care Ratio increased from 84.0% to 85.1%. This is due to the
increase in the Medical Care Ratio in Texas of almost 10%. The Nevada Medical
Care Ratio decreased slightly. The decrease in the Nevada ratio is due to price
increases in excess of cost increases offset by 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 decreased $16.3 million or 16.3%. The decrease is
consistent with the decrease 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 643,300 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 $8.5 million or 20.3%. Expenses increased
in the workers' compensation insurance segment by $9.6 million and
administrative services expense decreased by $1.1 million.
The increase in the workers' compensation insurance segment expenses is
primarily due to the following:
o Approximately $7.0 million in additional loss and loss adjustment expenses,
or LAE, related primarily to the increase in net earned premiums in 2001
compared to 2000.
o We recorded a lower loss and LAE ratio in the third quarter for the 2001
accident year, which resulted in a decrease of approximately $1.2 million.
The reduction in the loss ratio was due to the composite premium rate
increases obtained on new and renewal business.
o In the third quarter of 2001, we recorded $1.5 million of net adverse loss
development for prior accident years, primarily for accident years 1996 to
1998, compared to net positive development of $500,000 recorded in the
third quarter of 2000, primarily for accident years 1997 and 1998. The net
adverse development recorded in 2001 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 A net increase in underwriting expenses, policyholders' dividends and other
operating expenses of $1.8 million related primarily to the increase in net
earned premiums.
The net adverse loss development on prior accident years included those years
that were covered by our low level reinsurance agreement. This results in an
increase in the reinsurance recoverable balance which is then reduced by amounts
collectable from reinsurers. Net reinsurance recoverable decreased by $2.0
million in the third quarter of 2001 and increased by $14.7 million in the third
quarter of 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. This agreement terminated on June 30, 2001 on a
cut-off basis. We already had an existing excess of loss reinsurance agreement
that covered 100% of the losses above $500,000. The latter reinsurance agreement
is a fixed rate multi-year contract that will expire December 31, 2002. The
termination of the low level agreement will result in our keeping more retained
losses and LAE. However, 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 third quarter of 2001 were approximately 33%.
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 105.5% compared to 104.4% for 2000. The increase
was primarily due to prior year adverse development recorded during the third
quarter of 2001.
General, Administrative and Marketing Expenses, or G&A, increased $3.9
million or 11.4%. As a percentage of revenues, G&A expenses were 10.2% in
2001 compared to 9.1% for 2000. The 2000 G&A expenses, as a percentage of
revenue, was significantly lower due to the true-up of military contract
revenues in the third quarter of 2000 as previously discussed. Excluding the
true-up adjustment, G&A expenses increased primarily due to Texas settlement
costs and, to a lesser extent, due to increases in depreciation expense and
advertising and other related costs. As a percentage of medical premium revenue,
G&A expenses were 16.6% compared to 15.5% in 2000. Excluding the utilization
of premium deficiency reserves for maintenance costs of $148,000 for 2001 and
$384,000 for 2000, G&A expenses increased $3.7 million or 10.6% for the
period due to the items described above.
Asset Impairment Restructuring, Reorganization and Other Costs of $6.6 million
were recorded in 2001. As part of the Company's plan to exit Texas, as discussed
in Note 2 of the Notes to Condensed Consolidated Financial Statements, the
Company recorded $1.6 million to write down certain Texas furniture and
equipment, $2.0 million in lease and other termination costs, $1.8 million in
legal and restitution costs, $600,000 in various other exit related costs and
$570,000 in premium deficiency maintenance.
Interest Expense and Other, Net decreased $2.3 million or 37.4%, due primarily
to a decrease in the average balance of outstanding debt during the period which
was offset by an increase in the weighted average cost of borrowing. Our average
revolving credit facility balance was $43 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 and our interest rate swap
agreement, was 11.7% in 2001 compared to 10.5% in 2000. Our average interest
rate on the revolving credit facility, excluding the amortization of deferred
financing fees and our interest rate swap agreement was 7.59% in 2001 compared
to 10.29% in 2000. The decrease was offset by an increase in interest expense of
$2.3 million related to the net financing obligations associated with the
sale-leaseback transaction that was completed in December 2000.
Provision for Income Taxes was recorded as a benefit of $3.8 million compared to
a $1.3 million tax expense in 2000 with an effective tax rate of 33.5% compared
to 32.2% for 2000. Our ongoing effective tax rate is less than the statutory
rate due to tax preferred investments offset by state income taxes.
RESULTS OF OPERATIONS, NINE MONTHS ENDED SEPTEMBER 30, 2001, COMPARED TO NINE
MONTHS ENDED SEPTEMBER 30, 2000.
Medical Premiums increased $300,000 or .1%. The increase in premium revenue
reflects an 8.4% increase in Medicare member months (the number of months of
each year that an individual is enrolled in a plan) offset by a 16.4% decrease
in commercial 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
$44.2 million or 9.2%, commercial member months increased by 5.1% and Medicare
member months increased by 7.6%. 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% in Las Vegas. Our managed indemnity rates increased
approximately 11.3% and Medicare rates increased approximately 3.9%, of which a
portion is attributable to additional 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 September 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 $17.0 million or 7.1%. The increase in
revenue is primarily the result of additive change order work and 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 $36.9 million or 37.3%. Revenue increased
in the workers' compensation insurance segment by $37.9 million, which was
offset by a slight decrease in administrative services revenue of $1.0 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 6.5% 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 79.4% 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 of the new reinsurance agreements
compared to the low level agreements 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 future operating cash flow
and amounts available to be invested.
Professional Fees decreased $6.9 million or 23.8% due primarily to the closing
of our affiliated medical groups in Texas and Arizona during 2000.
Investment and Other Revenues increased $1.1 million or 7.2%, due primarily to
an increase in the average invested balance during the period offset by a
decrease in the average investment yield and net gains on sale of investments of
$.2 million in 2001 versus net losses on the sale of investments of $.9 million
in 2000.
Medical Expenses decreased $51.0 million or 8.1%. 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.
Medical expenses for 2001 include charges of $10.3 million for premium
deficiency medical, $600,000 for the write down of a medical related receivable
and 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 the charges and reclassification.
Excluding these items for both 2001 and 2000, medical expenses decreased $13.5
million or 2.4% and the Medical Care Ratio (medical expenses as a percentage of
medical premiums and professional fees) decreased from 83.4% to 82.2%. Excluding
the items above and the premium deficiency utilization of $14.1 million for 2001
and $16.4 million for 2000, the Medical Care Ratio decreased from 85.8% to
84.3%. 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 improvement 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 $17.5 million or 7.5%. 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 643,300
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 $24.2 million or 20.9%. Expenses increased
in the workers' compensation insurance segment by $26.4 million and
administrative services expense decreased by $2.2 million.
The increase in the workers' compensation insurance segment expenses is
primarily due to the following:
o Approximately $26.2 million in additional loss and LAE related to the
increase in net earned premiums in 2001 compared to 2000.
o In 2001, we recorded $7.3 million of net adverse loss development for
prior accident years, primarily 1996 to 1998, compared to net adverse
loss development of $20.2 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 loss and LAE ratio for the 2001 accident year,
which has resulted in an increase of approximately $7.0 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 loss and LAE.
o A net increase in underwriting expenses, policyholders' dividends and
other operating expenses of $6.1 million related primarily to the
increase in net earned premiums.
The net adverse loss development on prior accident years included those years
that were covered by our low level reinsurance agreement. This results in an
increase in the reinsurance recoverable balance which is then reduced by amounts
collectable from reinsurers. Net reinsurance recoverable increased by $8.6
million in 2001 and $73.7 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. This agreement terminated on June 30, 2001 on a
cut-off basis. We already had an existing excess of loss reinsurance agreement
that covered 100% of the losses above $500,000. The latter reinsurance agreement
is a fixed rate multi-year contract that will expire December 31, 2002. The
termination of the low level agreement will result in our keeping more retained
losses and LAE. However, 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 nine months of 2001 were approximately 40%.
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 106.0% compared to 120.9% for 2000. The decrease
was primarily due to significantly higher prior year adverse loss development
recorded during 2000. Excluding adverse loss development, the combined ratio
would have been 100.3% for 2001 and 102.1% for 2000. 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 $6.1
million or 5.9%. As a percentage of revenues, G&A expenses for 2001 were
10.0% compared to 9.9% for 2000. As a percentage of medical premium revenue,
G&A expenses were 16.6% compared to 15.7%. Excluding the utilization of
premium deficiency reserves for maintenance costs of $1.5 million for 2001 and
$9.4 million for 2000, G&A expenses decreased $1.8 million or 1.6% for the
period. The $1.8 million decrease was primarily attributable to a decrease in
payroll costs. Much of the payroll cost 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.
Asset Impairment, Restructuring, Reorganization and Other Costs were recorded in
2000 as described in Note 2 to the Condensed Consolidated Financial Statements.
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. During the third
quarter of 2001, as part of the Company's plan to exit Texas the Company
recorded $1.6 million to write down certain Texas furniture and equipment, $2.0
million in lease and other termination costs, $1.8 million in legal and
restitution costs, $600,000 in various other exit related costs and $570,000 in
premium deficiency maintenance.
Interest Expense and Other, Net decreased $2.3 million or 13.7%. Interest
expense related to the revolving credit facility decreased $8.0 million due to a
decrease in the average balance of outstanding debt during the period offset by
an increase in the weighted average cost of borrowing. Our average revolving
credit facility balance was $67 million in 2001 compared to $183 million in
2000. Our average interest rate on the revolving credit facility, including the
amortization of deferred financing fees and our interest rate swap agreement,
was 10.6% in 2001 compared to 9.7% in 2000. Our average interest rate on the
revolving credit facility, excluding the amortization of deferred financing fees
and our interest rate swap agreement was 8.53% in 2001 compared to 9.49% in
2000. CII debenture interest decreased by $1.5 million in 2001, primarily as a
result of the restructuring of the debentures. The decreases were offset by an
increase in interest expense of $7.2 million related to the net financing
obligations associated with the sale-leaseback transaction that was completed in
December 2000.
Provision for Income Taxes was a benefit of $782,000 compared to a $75.5 million
benefit in 2000. The effective tax rate was 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 $72.7 million for the nine
months ended September 30, 2001 compared to cash out-flows of $30.5 million for
2000. The improvement over 2000 is primarily attributable to collections from
outstanding military accounts receivable, timing of capitation payments from the
Centers for Medicare and Medicaid Services, and reinsurance recoveries.
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
receipts 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. 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 a portion of its accounts
receivable balance in order to improve the availability of cash. The total
military accounts receivable balance was $34.7 million as of September 30, 2001.
Cash used for investing activities during 2001 included $5.4 million in capital
expenditures offset by proceeds of $12.0 million for property and equipment
dispositions including a portion of the sale-leaseback properties. The net
change in investments for the period was $600,000 as investments were purchased
with cash from operations.
Cash used for financing activities included net payments of $41.0 million on the
revolving credit facility, $27.3 million for reductions of debentures, $9.9
million decrease in net financing obligations, and an additional $4.3 million in
payments on other outstanding debt and capital leases.
Revolving Credit Facility
Our revolving credit facility balance decreased from $135 million to $94 million
during the nine month period. The balance is reflected as long-term debt since
no portion of the outstanding balance is due in the next twelve months. The
revolving credit facility commitment was $121.1 million as of September 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 7.125% at September 30, 2001, which is a combination of the prime rate of
6.00% plus a margin of 1.125%. 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 impact of the swap agreement is not expected to be material to
our results of operations. 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 10.6%.
Debentures
CII Financial, Inc. had approximately $47.1 million of Subordinated Debentures
outstanding that were 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 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.
In September 2001, the California Department of Insurance gave approval to
California Indemnity, one of CII Financial's insurance subsidiaries, to pay a
dividend of $5.0 million to CII Financial. CII Financial used these funds to pay
the remaining $5.0 million in Subordinated Debentures at maturity.
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 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 the new 9 1/2% senior debentures may require that CII Financial
repurchase them at the then applicable redemption price, plus accrued and unpaid
interest.
CII Financial 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.
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 $25.4 million at September 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. In conjunction with the exit
from the Texas healthcare market, the Texas Department of Insurance approved a
plan of withdrawal and TXHC is now required to maintain deposits and net worth
of $3.5 million. We believe we are in compliance with our regulatory
requirements in all material respects.
Of the $159.7 million in cash and cash equivalents held at September 30, 2001,
$126.2 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.
Recent Events
We are not aware of any direct losses that may have occurred as a result of the
events of September 11, 2001 or the subsequent anthrax incidents. We have
reviewed the financial strength ratings of our primary reinsurers with certain
rating agencies subsequent to the events of September 11, 2001. The rating
agencies have either affirmed or left the ratings unchanged on all of our
primary reinsurers. As a result, we do not expect to incur any losses on our
reinsurance contracts as a result of the events of September 11, 2001.
The events of September 11, 2001 impacted the United States economy and has
impacted the amount of visitors traveling by air into Las Vegas. Certain of the
gaming properties that operate in Las Vegas have announced work force reductions
as a result of the reduced visitors. Only 13%, or approximately 22,000, of our
Nevada HMO membership come from gaming accounts and between September 1, 2001
and November 1, 2001, we have only experienced reductions of less than 100
members from our gaming accounts. While the Las Vegas visitor volume has
increased significantly since the events of September 11, 2001, there can be no
assurance that it will return to its historical levels prior to the events of
September 11, 2001 nor that we will not be impacted by further economic
deterioration. We believe that in a slowing economy, where medical costs are
rising, our healthcare products that help manage costs and coordinate care may
become more attractive as companies strive to manage their benefit costs.
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 capital items, expansion of
our operations, debt service and funding of the run-out of the Texas healthcare
operations. 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 September 30, 2001 and 2000 was as follows:
Number of Members at September 30
2001 2000
HMO
Commercial (1).............................................. 219,100 244,900
Medicare (2) (3)........................................... 59,400 53,000
Medicaid.................................................... 23,500 13,300
Managed Indemnity............................................. 29,300 31,100
Medicare Supplement........................................... 25,000 28,300
Administrative Services....................................... 299,100 282,900
TRICARE Eligibles............................................. 643,300 617,700
--------- ---------
Total Members................................................. 1,298,700 1,271,200
========= =========
(1) The number of commercial members at September 30, 2000 includes 25,000
members associated with the discontinued operations in Houston, Texas.
(2) The number of Medicare members at September 30, 2000 includes 5,300 members
associated with the discontinued operations in Houston, Texas.
(3) The 2001 Medicare membership does not include 5,400 Houston members that
the Company ceded to AmCare Health Plans of Texas, Inc. under a reinsurance
agreement on December 1, 2000.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of September 30, 2001, unrealized holding losses on available for sale
investments have decreased by $3.2 million since 2000 due primarily to an
increase 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 and other 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
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(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 September 7, 2001, with the
Securities and Exchange Commission in connection with the
announcement of the Company's participation in a health care
conference on September 13, 2001.
Current Report on Form 8-K, dated October 3, 2001, with the
Securities and Exchange Commission in connection with the
announcement of the Company's plans to exit the Texas healthcare
market.
Current Report on Form 8-K, dated October 26, 2001, with the
Securities and Exchange Commission in connection with the
announcement of the Company's participation in a health care
conference on October 30, 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: November 13, 2001 /S/ PAUL H. PALMER
Paul H. Palmer
Vice President of Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)