UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q/A
(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/A FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2001
INDEX
Page No.
--------
Part I - FINANCIAL INFORMATION
Item 1. 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............................................ 13
Item 3. Quantitative and Qualitative Disclosures
about Market Risk........................................................................ 22
Part II - OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 23
Item 2. Changes in Securities and Use Of Proceeds.................................................. 23
Item 3. Defaults Upon Senior Securities............................................................ 23
Item 4. Submission of Matters to a Vote of Security Holders........................................ 23
Item 5. Other Information.......................................................................... 23
Item 6. Exhibits and Reports on Form 8-K........................................................... 23
Signatures................................................................................................... 24
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.............................................. $ 147,695 $ 157,564
Investments............................................................ 214,212 206,935
Accounts Receivable (Less Allowance for Doubtful
Accounts: 2001 - $14,603; 2000 - $14,895).......................... 25,390 26,661
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............................. 88,889 91,477
Prepaid Expenses and Other Current Assets.............................. 40,280 30,912
Assets Held for Sale................................................... 3,458
Assets of Discontinued Operations...................................... 42,207 36,192
--------- ---------
Total Current Assets............................................... 642,716 671,291
Property And Equipment, Net................................................. 147,042 171,032
Long-Term Investments....................................................... 9,277 18,093
Restricted Cash And Investments............................................. 26,122 24,461
Reinsurance Recoverable, Net of Current Portion............................. 171,074 160,227
Deferred Tax Asset, Net of Current Portion.................................. 63,329 68,253
Other Assets................................................................ 56,640 51,743
--------- ---------
TOTAL ASSETS................................................................ $1,116,200 $1,165,100
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts Payable and Accrued Liabilities.................................. $ 77,466 $ 92,923
Medical Claims Payable.................................................... 77,568 74,404
Current Portion of Reserve for Losses and Loss Adjustment Expense......... 147,351 134,676
Unearned Premium Revenue.................................................. 51,146 41,499
Military Health Care Payable.............................................. 85,239 84,859
Current Portion of Long-term Debt......................................... 2,754 53,993
Liabilities of Discontinued Operations.................................... 103,586 110,620
--------- ---------
Total Current Liabilities.......................................... 545,110 592,974
Reserve For Losses And
Loss Adjustment Expense, Net of Current Portion........................... 263,258 239,878
Long-Term Debt, Net of Current Portion...................................... 194,195 224,970
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.................................. $184,402 $160,309 $522,806 $ 478,594
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 7,580 22,056 26,202
Investment and Other Revenues..................... 4,525 5,386 16,276 16,929
------- ------- ------- --------
Total....................................... 330,854 315,300 952,409 859,119
------- ------- ------- --------
Operating Expenses:
Medical Expenses (Note 2)......................... 156,307 138,374 443,595 441,121
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.... 30,084 25,263 86,701 79,497
Asset Impairment, Restructuring, Reorganization
and Other Costs (Note 3)..................... 33,836
------- ------- ------- --------
Total ...................................... 320,096 305,197 920,198 902,729
------- ------- ------- --------
Operating Income (Loss).............................. 10,758 10,103 32,211 (43,610)
Interest Expense and Other, Net .................... (3,888) (4,854) (14,450) (13,809)
------- ------- ------- --------
Income (Loss) from Continuing Operations Before Taxes 6,870 5,249 17,761 (57,419)
Income Tax (Provision) Benefit....................... (2,298) (1,708) (5,946) 14,803
------- ------- -------- --------
Net Income (Loss) from Continuing Operations......... 4,572 3,541 11,815 (42,616)
Loss from Discontinued Operations (Note 4)........... (12,126) (872) (13,369) (159,876)
------- ------- ------- --------
Net (Loss) Income.................................... $ (7,554) $ 2,669 $ (1,554) $(202,492)
======= ======= ======= ========
Earnings per Common Share:
-------------------------
Net Income (Loss) from Continuing Operations......... $ .16 $ .13 $ .43 $(1.57)
Loss from Discontinued Operations.................... (.43) (.03) (.49) (5.90)
---- ---- ---- -----
Net (Loss) Income................................. $(.27) $ .10 $(.06) $(7.47)
==== ==== ==== =====
Earnings per Common Share Assuming Dilution:
-------------------------------------------
Net Income (Loss) from Continuing Operations......... $ .16 $ .13 $ .42 $(1.57)
Loss from Discontinued Operations.................... (.42) (.03) (.47) (5.90)
---- ---- ---- -----
Net (Loss) Income................................. $(.26) $ .10 $(.05) $(7.47)
==== ==== ==== =====
Weighted Average Common Shares Outstanding........... 27,851 27,248 27,619 27,092
Weighted Average Common Shares Outstanding
Assuming Dilution................................. 29,270 27,250 28,316 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:
Loss from Discontinued Operations................................ 13,369 159,876
Provision for Asset Impairment and Other Charges................. 39,079
Depreciation and Amortization.................................... 18,439 19,373
Provision for Doubtful Accounts.................................. 1,899 2,014
Loss on Property and Equipment Dispositions...................... 2,399
Changes in Assets and Liabilities....................................... 55,452 (67,137)
------- -------
Net Cash Provided by (Used for) Operating Activities ............... 90,004 (49,287)
------- -------
Cash Flows From Investing Activities:
Capital Expenditures, Net of Dispositions............................... 7,215 (11,774)
Changes in Investments.................................................. (839) 23,435
------- --------
Net Cash Provided by Investing Activities........................... 6,376 11,661
------- --------
Cash Flows From Financing Activities:
Proceeds from Borrowings................................................ 25,000
Payments on Debt and Capital Leases..................................... (82,015) (6,566)
Issuance of Stock in Connection with Stock Plans........................ 2,180 1,572
------- --------
Net Cash (Used for) Provided by Financing Activities................ (79,835) 20,006
------- --------
Cash (Used for) Provided by Discontinued Operations........................ (26,414) 22,075
------- --------
Net (Decrease) Increase In Cash and Cash Equivalents....................... (9,869) 4,455
Cash and Cash Equivalents at Beginning of Period........................... 157,564 53,867
------- --------
Cash and Cash Equivalents at End Of Period................................. $147,695 $ 58,322
======= ========
Supplemental Condensed Consolidated Continuing Operations Nine Months Ended September 30
Statements of Cash Flows Information: 2001 2000
------------------------------------------------------------------------ ---- ----
Cash Paid During the Period for Interest
(Net of Amount Capitalized)............................................. $14,423 $17,529
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. Principles of Consolidation
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 the nine months ended September
30, 2000, are changes in estimate charges of $16.5 million of reserve
strengthening, primarily due to adverse development on prior periods'
medical claims. In addition, the Company recorded $9.5 million of other
non-recurring medical costs primarily relating to the write-down of medical
subsidiary assets.
3. Asset Impairment, Restructuring, Reorganization and Other Costs
The table below presents a summary of asset impairment, restructuring,
reorganization and other cost activity for the periods indicated.
Discontinued Texas healthcare operations are excluded from the table.
Restructuring
Asset and
(In thousands) Impairment Reorganization Other Total
---------- -------------- ----- -----
Balance, January 1, 2000........... $ 3,449 $ 3,449
Charges recorded................... $27,553 $1,983 4,300 33,836
Cash used.......................... (1,389) (302) (1,691)
Noncash activity................... (27,553) (3,000) (30,553)
Changes in estimate................
------- ----- ------ -------
Balance, December 31, 2000......... - 594 4,447 5,041
Charges recorded...................
Cash used.......................... (347) (347)
Noncash activity...................
Changes in estimate................
------- ----- ------ -----
Balance, September 30, 2001........ $ - $ 247 $ 4,447 $ 4,694
======= ====== ====== =======
Asset impairment charges recorded in 2000 were primarily for goodwill
related to discontinued medical providers and other impaired fixed assets.
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. Discontinued Operations
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which is
effective for fiscal years beginning after December 15, 2001 with early
adoption recommended. The Company has elected to adopt SFAS 144 effective
January 1, 2001. During the third quarter of 2001, the Company announced
its plan to exit the Texas healthcare market and received formal approval
from the Texas Department of Insurance to withdraw its healthcare
operations in mid-October. The Company will cease providing healthcare
services in Texas on April 17, 2002. In accordance with SFAS 144, the
Company's Texas healthcare operations have been reclassified as
discontinued operations.
The following are unaudited condensed statements of operations of the
discontinued Texas healthcare operations:
Three Months Ended Nine Months Ended
September 30 September 30
2001 2000 2001 2000
---- ---- ---- ----
Operating Revenues.................................. $ 45,474 $62,182 $137,744 $ 182,593
------- ------ ------- --------
Medical Expenses.................................... 49,042 53,192 136,259 189,752
General, Administrative and Marketing Expenses...... 8,184 9,064 22,766 23,815
Asset Impairment, Restructuring, Reorganization
And Other Costs.................................. 6,550 (1,250) 186,604
Interest Expense and Other, Net..................... (74) 1,237 66 3,019
------- ------ ------- --------
Loss from Discontinued Operations Before Tax........ (18,228) (1,311) (20,097) (220,597)
Income Tax Benefit.................................. 6,102 439 6,728 60,721
------- ------ ------- --------
Net Loss from Discontinued Operations............... $(12,126) $ (872) $(13,369) $(159,876)
======= ====== ======= ========
All of the discontinued Texas healthcare operations were designated as part
of the "managed care and corporate operations" reporting segment.
Included in the Texas healthcare operations medical expenses for the nine
months ended September 30, 2000 are $14.7 million, primarily for adverse
development on prior periods' medical claims, and $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
reflected anticipated costs after restructuring and reorganization actions
taken in the first six months of 2000. 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 general, administrative and marketing
expenses on the condensed statements of operations of discontinued Texas
healthcare operations.
Included in the Texas healthcare operations general, administrative and
marketing expenses for the nine months ended September 30, 2000 are the
following: (a) asset impairment charges of $126.4 million for impaired
goodwill; (b) $36.5 million for impaired real estate and other fixed
assets; (c) $10.4 million for premium deficiency maintenance costs; and (d)
other restructuring, reorganization and other costs of $13.3 million.
Throughout 2001, the Company continued to focus on making the Dallas/Ft.
Worth operations profitable. Significant premium rate increases were 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. The Company has also received a limited waiver under
its revolving credit facility agreement for all covenants affected by
exiting the Texas healthcare market.
As part of the Company's plan to exit Texas, the Company recorded $10.6
million for premium deficiency medical costs, $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, $500,000 in
various other exit related costs and $570,000 in premium deficiency
maintenance.
The table below presents a summary of discontinued Texas healthcare
operations' 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 $ 11,000
Charges recorded................ $ 162,937 $11,509 10,358 $1,800 186,604
Cash used....................... (7,754) (12,080) (200) (20,034)
Noncash activity................ (162,937) (800) (163,737)
Changes in estimate.............
-------- ------ ------ ----- --------
Balance, December 31, 2000...... - 3,755 9,278 800 13,833
Charges recorded................ 1,600 4,380 570 6,550
Cash used....................... (2,099) (1,478) (800) (4,377)
Noncash activity................ (1,600) (125) (1,725)
Changes in estimate............. (7,800) (7,800)
-------- ------ ------ ----- --------
Balance, September 30, 2001..... $ - $ 5,911 $ 570 $ - $ 6,481
======== ====== ====== ===== ========
Of the remaining restructuring and reorganization costs of $5.9 million,
$4.4 million is related to the charges incurred in the third quarter of
2001 as described above, and $1.5 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. 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. 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.
The following are the unaudited assets and liabilities of the discontinued
Texas healthcare operations:
September 30 December 31
(In thousands) 2001 2000
---- ----
ASSETS
Cash and Cash Equivalents............................... $ 12,040 $ 3,742
Accounts Receivable, Net................................ 2,866 6,433
Other Assets............................................ 7,214 4,534
Property and Equipment, Net............................. 20,087 21,483
-------- --------
TOTAL ASSETS............................................ 42,207 36,192
-------- ---------
LIABILITIES
Accounts Payable and Other Liabilities.................. 15,780 17,158
Medical Claims Payable.................................. 34,101 37,892
Unearned Premium Revenue................................ 10,054 6,874
Premium Deficiency Reserve.............................. 9,788 14,466
Mortgage Loan Payable................................... 33,863 34,230
-------- ---------
TOTAL LIABILITIES....................................... 103,586 110,620
-------- ---------
NET LIABILITIES OF DISCONTINUED OPERATIONS.............. $(61,379) $(74,428)
======== =======
Property and equipment consists mainly of real estate properties located in
the Dallas/Ft. Worth metroplex areas. Texas Health Choice LLP, a
wholly-owned subsidiary of the Company, acquired these properties from
Kaiser Foundation Health Plan of Texas ("Kaiser-Texas") for $44 million as
part of the acquisition of certain assets of Kaiser-Texas in October 1998.
In June 2000, as part of its restructuring and reorganization of the
Dallas/Ft. Worth healthcare operations, the Company announced its
intentions to sell these properties. The real estate was written down to
its estimated fair value and the Company took an asset impairment charge of
$27 million. The real estate is encumbered by a mortgage loan to
Kaiser-Texas. The mortgage loan balance at September 30, 2001 was $33.9
million. See Note 9, Subsequent Events.
5. Earnings Per Share:
The following table provides a reconciliation of basic and diluted earnings per
share ("EPS") for continuing operations:
Dilutive
(In thousands, except per share data) Basic Stock Options Diluted
----- ------------- -------
For the Three Months ended September 30, 2001:
Income from Continuing Operations $ 4,572 $ 4,572
Shares 27,851 1,419 29,270
Per Share Amount $ .16 $ .16
For the Three Months ended September 30, 2000:
Income from Continuing Operations $ 3,541 $ 3,541
Shares 27,248 2 27,250
Per Share Amount $ .13 $ .13
For the Nine Months ended September 30, 2001:
Income from Continuing Operations $ 11,815 $ 11,815
Shares 27,619 697 28,316
Per Share Amount $ .43 $ .42
For the Nine Months ended September 30, 2000:
Loss from Continuing Operations $(42,616) $(42,616)
Shares 27,092 27,092
Per Share Amount $(1.57) $(1.57)
Outstanding stock options were not included in the computation of diluted EPS
for the nine months ended September 30, 2000 because their effect would have
been antidilutive.
6. 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)
====== ===== ===== ========
7. 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. Discontinued Texas healthcare
operations are excluded. 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 reportable segments for continuing operations is as follows:
Managed Care Military Workers'
and Corporate Health Services Compensation
(In thousands) Operations Operations Operations Total
---------------- ---------------- ----------------- -----
Three Months Ended September 30, 2001
Medical Premiums.......................... $ 184,402 $184,402
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............. 296 659 3,570 4,525
--------- -------- ------- -------
Total Revenue.......................... $ 193,587 $ 86,158 $ 51,109 $330,854
======== ======== ======= =======
Segment Operating Profit.................. $ 6,888 $ 2,597 $ 1,273 $ 10,758
Interest Expense and Other, Net........... (3,412) 31 (507) (3,888)
-------- -------- ------- -------
Income Before Income Taxes................ $ 3,476 $ 2,628 $ 766 $ 6,870
======== ======== ======= =======
Three Months Ended September 30, 2000
Medical Premiums.......................... $ 160,309 $160,309
Military Contract Revenues................ $ 101,259 101,259
Specialty Product Revenues................ 2,166 $ 38,600 40,766
Professional Fees......................... 7,580 7,580
Investment and Other Revenues............. 1,404 147 3,835 5,386
-------- -------- ------- -------
Total Revenue.......................... $ 171,459 $ 101,406 $ 42,435 $315,300
======== ======== ======= =======
Segment Operating Profit.................. $ 6,256 $ 1,518 $ 2,329 $ 10,103
Interest Expense and Other, Net........... (4,074) (74) (706) (4,854)
-------- -------- ------- -------
Income Before Income Taxes................ $ 2,182 $ 1,444 $ 1,623 $ 5,249
======== ======== ======= =======
Nine Months Ended September 30, 2001
Medical Premiums.......................... $ 522,806 $522,806
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............. 2,508 1,821 11,947 16,276
-------- -------- ------- -------
Total Revenue.......................... $ 553,183 $ 257,318 $141,908 $952,409
======== ======== ======= =======
Segment Operating Profit.................. $ 20,249 $ 6,986 $ 4,976 $ 32,211
Interest Expense and Other, Net........... (13,194) 14 (1,270) (14,450)
-------- -------- ------- -------
Income (Loss) Before Income Taxes......... $ 7,055 $ 7,000 $ 3,706 $ 17,761
======== ======= ====== =======
Nine Months Ended September 30, 2000
Medical Premiums.......................... $ 478,594 $478,594
Military Contract Revenues................ $ 238,514 238,514
Specialty Product Revenues................ 6,858 $ 92,022 98,880
Professional Fees......................... 26,202 26,202
Investment and Other Revenues............. 5,527 601 10,801 16,929
-------- -------- ------- -------
Total Revenue.......................... $ 517,181 $ 239,115 $102,823 $859,119
======== ======== ======= =======
Segment Operating Profit (1).............. $ 17,669 $ 6,245 $ 8,823 $ 32,737
Interest Expense and Other, Net........... (11,694) (439) (1,676) (13,809)
Changes in Estimate Charges (2)........... (26,011) (16,500) (42,511)
Asset Impairment, Restructuring,
Reorganization and Other Costs....... (30,836) (3,000) (33,836)
-------- -------- ------- -------
(Loss) Income Before Income Taxes......... $ (50,872) $ 5,806 $(12,353) $(57,419)
======== ======== ======= =======
(1) The segment operating profit excludes the effects of changes in estimate
charges and asset impairment, restructuring, reorganization and other
costs.
(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.
8. 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.
9. Subsequent Events
A settlement agreement was reached with Kaiser-Texas effective December 31,
2001 relating to the Sierra guarantee of the mortgage debt obligation and
other issues related to the acquisition of the Kaiser-Texas assets in 1998.
As part of the settlement, Kaiser-Texas agreed to reduce the principal loan
balance by $8.5 million and a receivable due to the Company from
Kaiser-Texas of $2.5 million was applied to the principal balance of the
mortgage loan. Monthly mortgage payments were also suspended for a twelve
month period starting February 2002 and the loan maturity was extended by
three years to November 1, 2006. Sierra agreed to unconditionally guarantee
the mortgage debt obligation as well as dismiss all other issues related to
the Kaiser-Texas acquisition.
The settlement included concessions by Kaiser-Texas, including a reduction
in principal and an extension of the maturity. In accordance with
accounting principles generally accepted in the United States of America,
the agreement was treated as a restructuring of debt. Total future cash
payments (interest and principal) on the revised mortgage loan were less
than the principal balance of the mortgage loan at the time of the
settlement. Accordingly, a gain on restructuring was recognized for the
difference and the carrying amount of the revised mortgage loan is the
total future cash payments on the mortgage loan. Costs incurred in
connection with the settlement were used to offset the gain on
restructuring. Effective January 1, 2002, all future cash payments related
to the mortgage loan will be reductions of the carrying amount of the
mortgage loan; therefore, no future interest expense will be recognized for
the mortgage loan. The transaction resulted in a gain before taxes of
$1,220,000 in the fourth quarter of 2001.
10. 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 for fiscal years beginning after
December 15, 2001 with early adoption recommended. 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. As noted in Note 4 above, the
Company elected to adopt SFAS 144 effective January 1, 2001.
11. 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/A 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 $24.1 million or 15.0%. The increase in premium
revenue reflects a 15.4% increase in commercial member months (the number of
months of each year that an individual is enrolled in a plan) and an 9.3%
increase in Medicare member months. 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.
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.
SIERRA HEALTH SERVICES, INC. AND SUBSIDAIRES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION, Continued
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 a new
reinsurance agreement with lower ceded premiums.
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 $.6 million or 7.9% due primarily to the closing of
our affiliated medical group in Arizona during 2000 and decreased fee for
service revenue in Las Vegas.
Investment and Other Revenues decreased $861,000 or 16.0% 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 $17.9 million or 13.0%. The Medical Care Ratio
(medical expenses as a percentage of medical premiums and professional fees)
decreased from 82.4% to 81.7%. The decrease in the 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 $4.8 million
or 19.1%. As a percentage of revenues, G&A expenses were 9.1% in 2001 compared
to 8.0% for 2000. The 2000 G&A expenses, as a percentage of revenue, were lower
due in part to the true-up of military contract revenues in the third quarter of
2000, as previously discussed, and to increases in depreciation expense and
advertising and other related costs. As a percentage of medical premium revenue,
G&A expenses were 16.3% compared to 15.8% in 2000. The increase was due to
higher staffing costs and other related expenses to service the growth in
membership.
Interest Expense and Other, Net decreased $966,000 or 19.9%, 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 $2.3 million compared to $1.7 million in 2000
with an effective tax rate of 33.5% compared to 32.5% for 2000. Our ongoing
effective tax rate is less than the statutory rate due to tax preferred
investments offset by state income taxes.
Discontinued Operations consist entirely of our Texas healthcare operations. See
Note 4 of the Notes to Condensed Consolidated Financial Statements. We elected
to implement Statement of Financial Accounting Standards No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," or SFAS 144, effective
January 1, 2001. In the third quarter of 2001, we decided to exit the Texas
healthcare market and received approval from the Texas Department of Insurance
in mid-October 2001. We will stop providing healthcare services on April 17,
2002. In accordance with SFAS 144, our Texas healthcare operations are now
reclassified as a discontinued operation. The net loss from discontinued
operations was $12.1 million compared to $872,000 in 2000. Included in 2001 loss
are estimated costs to exit the Texas market of approximately $17.1 million or
$11.4 million net of tax. Prior premium deficiency reserves utilized were $7.1
million in 2001 and $2.0 million in 2000.
RESULTS OF OPERATIONS, NINE MONTHS ENDED SEPTEMBER 30, 2001, COMPARED TO NINE
MONTHS ENDED SEPTEMBER 30, 2000.
Medical Premiums increased $44.2 million or 9.2%. The increase in premium
revenue reflects a 7.6% increase in Medicare member months (the number of months
of each year that an individual is enrolled in a plan) and a 5.1% increase in
commercial member months. 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 a new
reinsurance agreement with lower ceded premiums.
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 $4.1 million or 15.8% due primarily to the closing
of our affiliated medical groups in Arizona during 2000.
Investment and Other Revenues decreased $653,000 or 3.9%, due primarily to a
decrease in the average investment yield during the period offset by an increase
in the average invested balance 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 increased $2.5 million or .6%. The Medical Care Ratio (medical
expenses as a percentage of medical premiums and professional fees) decreased
from 87.4% to 81.4%. Included in medical expenses for 2000 are charges of $16.5
million for reserve strengthening, primarily for adverse development related to
prior periods' medical claims, and $9.5 million of other non-recurring medical
costs. Excluding these items for 2000, medical expenses increased $28.5 million
or 6.5% and the Medical Care Ratio decreased from 82.2% to 81.4%. The
improvement is primarily due to the closing and sale of operations with higher
medical care ratios in rural Nevada and Arizona 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 $7.2 million
or 9.1%. As a percentage of revenues, G&A expenses for 2001 were 9.1% compared
to 9.3% for 2000. As a percentage of medical premium revenue, G&A expenses were
16.6% for both periods.
Asset Impairment, Restructuring, Reorganization and Other Costs were recorded in
2000 as described in Note 3 to the Condensed Consolidated Financial Statements.
Interest Expense and Other, Net increased $641,000 or 4.6%. 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 and a loss of $2.4 million on the sale of our Arizona properties.
Provision for Income Taxes was $5.9 million compared to a $14.8 million benefit
in 2000. The effective tax rate was 33.5% compared to 25.8% 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.
Discontinued Operations consist entirely of our Texas healthcare operations. See
Note 4 of the Notes to Condensed Consolidated Financial Statements. We elected
to implement Statement of Financial Accounting Standards No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets," or "SFAS 144", effective
January 1, 2001. In the third quarter of 2001, we decided to exit the Texas
healthcare market and received approval from the Texas Department of Insurance
in mid-October 2001. We will stop providing healthcare services on April 17,
2002. In accordance with SFAS 144, our Texas healthcare operations are now
reclassified as a discontinued operation. The net loss from discontinued
operations was $13.4 million in 2001 compared to $159.9 million in 2000.
Included in the 2001 loss are estimated costs to exit the Texas market of $17.1
million. Included in the 2000 loss were the following: (a) asset impairment
charges of $126.4 million for impaired goodwill; (b) $36.5 million for impaired
real estate and other fixed assets; (c) medical expenses of $14.7 million,
primarily for adverse development on prior periods' medical claims; (d) $15.5
million for premium deficiency medical costs; (e) $10.4 million for premium
deficiency maintenance costs; and (f) other restructuring, reorganization and
other costs of $13.3 million. The utilization of prior premium deficiency
reserves were $15.6 million in 2001 and $25.8 million in 2000.
LIQUIDITY AND CAPITAL RESOURCES
For continuing operations, we had cash in-flows from operating activities of
$90.0 million during 2001 compared to cash out-flows of $49.3 million in 2000.
The improvement over 2000 is primarily attributable to collections from
outstanding military accounts receivable, timing of Medicare 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.
For continuing operations, cash provided by investing activities during 2001 was
$6.4 million compared to $11.7 million in 2000. The 2001 amount included $4.4
million in capital expenditures offset by proceeds of $11.7 million for property
and equipment dispositions, including a portion of the sale-leaseback
properties. The net change in investments for the period was an increase of
$839,000 as investments were purchased with cash from operations.
For continuing operations, cash used for financing activities during 2001 was
$79.8 million compared to $20.0 million in 2000. The 2001 amount 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 $3.8 million in payments on other outstanding debt and capital
leases.
Discontinued Texas healthcare operations used cash of $26.4 million during 2001
compared to providing cash of $22.1 million in 2000. The cash used in 2001 was
primarily due to higher payments for medical and operating expenses and lower
premium revenues. The cash provided in 2000 was primarily due to higher premium
revenues and comparable lower medical and operating expense payments.
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 were 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 $147.7 million in cash and cash equivalents held at September 30, 2001
for continuing operations, $113.9 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.
September 11 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 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 discontinued
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
---- ----
Continuing Operations:
---------------------
HMO
Commercial.................................................. 168,200 143,000
Medicare.................................................... 45,300 41,200
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, Continuing Operations.......................... 1,233,700 1,157,500
========= =========
Discontinued Texas Operations:
-----------------------------
HMO
Commercial.................................................. 50,900 101,900
Medicare (1) ............................................... 14,100 11,800
------ --------
Total Members, Discontinued Operations........................ 65,000 113,700
====== =======
(1) 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.
SIERRA HEALTH SERVICES, INC. AND SUBSIDAIRES
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, for example, 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: February 28, 2002 /S/ PAUL H. PALMER
-----------------------------------
Paul H. Palmer
Vice President of Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)