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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________________ to ______________________
Commission File Number 1-8865
SIERRA HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)
NEVADA 88-0200415
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2724 NORTH TENAYA WAY
LAS VEGAS, NV 89128
(Address of principal executive offices) (Zip Code)
(702) 242-7000
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
As of August 2, 2002, there were 28,795,000 shares of common stock
outstanding.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
FORM 10-Q FOR THE SIX MONTHS ENDED JUNE 30, 2002
INDEX
Page No.
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
June 30, 2002 and December 31, 2001....................................................... 3
Condensed Consolidated Statements of Operations -
three and six months ended June 30, 2002 and 2001......................................... 4
Condensed Consolidated Statements of Cash Flows -
six months ended June 30, 2002 and 2001................................................... 5
Notes to Condensed Consolidated Financial Statements....................................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............................................. 15
Item 3. Quantitative and Qualitative Disclosures
about Market Risk......................................................................... 27
Part II - OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 28
Item 2. Changes in Securities and Use Of Proceeds.................................................. 28
Item 3. Defaults Upon Senior Securities............................................................ 28
Item 4. Submission of Matters to a Vote of Security Holders........................................ 28
Item 5. Other Information.......................................................................... 29
Item 6. Exhibits and Reports on Form 8-K........................................................... 29
Signatures................................................................................................... 30
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
(Unaudited)
ASSETS
June 30, December 31,
2002 2001
Current Assets:
Cash and Cash Equivalents.............................................. $ 76,714 $ 115,754
Investments............................................................ 323,245 260,762
Accounts Receivable (Less Allowance for Doubtful
Accounts: 2002 - $9,815; 2001 - $12,655)........................... 25,248 26,003
Military Accounts Receivable........................................... 43,375 40,166
Current Portion of Deferred Tax Asset.................................. 54,219 35,869
Current Portion of Reinsurance Recoverable............................. 91,871 96,762
Prepaid Expenses and Other Current Assets.............................. 29,529 31,640
Assets of Discontinued Operations...................................... 24,563 28,404
------- ---------
Total Current Assets............................................... 668,764 635,360
Property and Equipment, Net................................................. 86,914 141,451
Long-Term Investments....................................................... 5,411 8,434
Restricted Cash and Investments............................................. 31,981 26,011
Reinsurance Recoverable, Net of Current Portion............................. 109,794 123,383
Deferred Tax Asset, Net of Current Portion.................................. 36,455 77,036
Goodwill ................................................................... 14,782 14,782
Other Assets................................................................ 44,282 43,505
------- ---------
TOTAL ASSETS................................................................ $998,383 $1,069,962
======= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accrued Liabilities.................................................... $ 61,181 $ 53,546
Trade Accounts Payable................................................. 16,696 21,578
Accrued Payroll and Taxes.............................................. 24,833 14,390
Medical Claims Payable................................................. 95,460 81,662
Current Portion of Reserve for Losses and Loss Adjustment Expense...... 164,337 142,342
Unearned Premium Revenue............................................... 28,350 52,919
Military Health Care Payable........................................... 81,007 77,261
Current Portion of Long-term Debt...................................... 1,623 1,612
Liabilities of Discontinued Operations................................. 53,118 83,931
------- ---------
Total Current Liabilities.......................................... 526,605 529,241
Reserve For Losses and
Loss Adjustment Expense, Net of Current Portion........................... 227,420 243,363
Long-Term Debt, Net of Current Portion...................................... 93,765 181,759
Other Liabilities........................................................... 31,391 19,080
------- ---------
TOTAL LIABILITIES........................................................... 879,181 973,443
------- ---------
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: 30,069 and 29,648 issued as of 2002
and 2001, respectively.............................................. 150 148
Additional Paid-in Capital................................................ 184,449 181,076
Deferred Compensation for Restricted Stock................................ (766) (1,058)
Treasury Stock; 2002 and 2001 - 1,523 Common Stock Shares................. (22,789) (22,789)
Accumulated Other Comprehensive Loss...................................... (4,524) (5,636)
Accumulated Deficit....................................................... (37,318) (55,222)
------- ---------
Total Stockholders' Equity......................................... 119,202 96,519
------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................. $998,383 $1,069,962
======= =========
See accompanying notes to condensed consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
2002 2001 2002 2001
Operating Revenues:
Medical Premiums.................................. $211,408 $172,402 $418,052 $338,404
Military Contract Revenues........................ 93,740 88,086 179,194 169,998
Specialty Product Revenues........................ 46,280 44,901 90,377 86,327
Professional Fees................................. 7,704 7,746 15,226 15,075
Investment and Other Revenues..................... 4,836 5,192 9,699 11,751
------- ------- ------- -------
Total....................................... 363,968 318,327 712,548 621,555
------- ------- ------- -------
Operating Expenses:
Medical Expenses.................................. 176,112 145,601 351,444 287,288
Military Contract Expenses........................ 89,862 86,333 172,216 166,771
Specialty Product Expenses........................ 48,137 45,555 94,403 89,426
General, Administrative and Marketing
Expenses (Note 2).............................. 32,080 29,447 62,732 56,617
------- ------- ------- -------
Total ...................................... 346,191 306,936 680,795 600,102
------- ------- ------- -------
Operating Income from Continuing Operations.......... 17,777 11,391 31,753 21,453
Interest Expense and Other, Net...................... (1,953) (5,712) (4,830) (10,562)
Income from Continuing Operations Before Taxes....... 15,824 5,679 26,923 10,891
Income Tax Provision................................. (5,301) (1,902) (9,019) (3,648)
------- ------- ------- -------
Net Income from Continuing Operations................ 10,523 3,777 17,904 7,243
Loss from Discontinued Operations (Note 3)........... (982) (1,243)
------- ------- ------- -------
Net Income........................................... $ 10,523 $ 2,795 $ 17,904 $ 6,000
======= ======= ======= =======
Earnings per Common Share:
- -------------------------
Net Income from Continuing Operations................ $.37 $ .14 $.64 $ .26
Loss from Discontinued Operations.................... (.04) (.04)
--- ---- --- ----
Net Income........................................ $.37 $ .10 $.64 $ .22
=== ==== === ====
Earnings per Common Share Assuming Dilution:
- -------------------------------------------
Net Income from Continuing Operations................ $.34 $ .13 $.59 $ .26
Loss from Discontinued Operations.................... (.03) (.04)
--- ---- --- ----
Net Income........................................ $.34 $ .10 $.59 $ .22
=== ==== === ====
Weighted Average Common Shares Outstanding........... 28,207 27,515 28,146 27,501
Weighted Average Common Shares Outstanding
Assuming Dilution................................. 30,899 28,002 30,529 27,895
See accompanying notes to condensed consolidated financial statements.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended June 30,
2002 2001
Cash Flows From Operating Activities:
Net Income.............................................................. $ 17,904 $ 6,000
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Loss from Discontinued Operations................................ 1,243
Depreciation and Amortization.................................... 10,354 12,250
Provision for Doubtful Accounts.................................. 1,666 1,317
Deferred Compensation Expense.................................... 292
Loss on Property and Equipment Dispositions...................... 157 2,370
Changes in Assets and Liabilities
Reinsurance Recoverable.......................................... 18,480 (11,148)
Medical Claims Payable........................................... 13,798 (1,675)
Military Accounts Receivable..................................... (3,209) 30,909
Unearned Premiums................................................ (24,569) 7,982
Other Assets and Liabilities..................................... 40,993 11,567
------- -------
Net Cash Provided by Operating Activities .......................... 75,866 60,815
------- -------
Cash Flows From Investing Activities:
Capital Expenditures, Net of Dispositions............................... (3,695) (1,847)
Changes in Investments.................................................. (57,693) (6,364)
------- -------
Net Cash Used for Investing Activities.............................. (61,388) (8,211)
------- -------
Cash Flows From Financing Activities:
Payments on Debt and Capital Leases..................................... (29,930) (61,263)
Issuance of Stock in Connection with Stock Plans........................ 3,384 650
------- -------
Net Cash Used for Financing Activities.............................. (26,546) (60,613)
------- -------
Net Cash Used for Discontinued Operations.................................. (26,972) (21,439)
Net Decrease In Cash and Cash Equivalents.................................. (39,040) (29,448)
Cash and Cash Equivalents at Beginning of Period........................... 115,754 157,564
------- -------
Cash and Cash Equivalents at End Of Period................................. $ 76,714 $128,116
======= =======
Supplemental Condensed Consolidated Continuing Operations Six Months Ended June 30,
Statements of Cash Flows Information: 2002 2001
- ---------------------------------------------------------------------------
Cash Paid During the Period for Interest
(Net of Amount Capitalized)............................................. $ 3,800 $10,781
Net Cash Received (Paid) During the Period for Income Taxes................ 13,104 (45)
Non-cash Investing and Financing Activities:
Retired Sale-Leaseback Assets, Liabilities
and Financing Obligations (Note 6).................................. 58,053
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. Basis of Presentation
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, 2001 and 2000. 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.
Certain amounts in the Condensed Consolidated Financial Statements for the
three and six months ended June 30, 2001 have been reclassified to conform
with the current year presentation.
2. 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 that are
included in general, administrative and marketing expenses. Discontinued
Texas HMO health care operations are excluded from this table and are
discussed in Note 3.
Restructuring
and
Reorganization Other Total
(In thousands)
Balance, January 1, 2001......................... $ 594 $4,447 $5,041
Charges recorded.................................
Cash used........................................ (594) (594)
Noncash activity.................................
Changes in estimate..............................
------ ----- -----
Balance, December 31, 2001....................... - 4,447 4,447
Charges recorded.................................
Cash used........................................
Noncash activity................................. (500) (500)
Changes in estimate..............................
------ ----- -----
Balance, June 30, 2002........................... $ - $3,947 $3,947
====== ===== =====
The remaining other costs of $3.9 million are related to legal claims.
Management believes that the remaining reserves, as of June 30, 2002, are
appropriate and that no revisions to the estimates are necessary at this
time.
3. Discontinued Operations
Throughout 2001, the Company continued to focus on making the Texas HMO
health care 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 then 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 HMO health care market and received
formal approval, in mid October, from the Texas Department of Insurance to
withdraw its HMO operations. The Company ceased providing HMO health care
coverage in Texas on April 17, 2002.
The Company elected to early adopt Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS No. 144"), effective January 1, 2001. In accordance with
SFAS No. 144, the Company's Texas HMO health care operations were
reclassified as discontinued operations. The Company has received a limited
waiver under its revolving credit facility agreement for covenants affected
by exiting the Texas HMO health care market.
Prior to the adoption of SFAS No. 144, all of the discontinued Texas HMO
health care operations were presented as a component of the "managed care
and corporate operations" segment.
In conjunction with the Company's plan to exit Texas, during the third
quarter of 2001, the Company recorded charges of $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.
As part of the Company's continual evaluation of its remaining liabilities,
it was determined during the second quarter of 2002, that the medical
claims run out had been favorable compared with the Company's original
projection. During the second quarter, the claims run out had developed to
a level that it became apparent that the Company had excess medical claims
payable recorded. The Company, however, also determined during the second
quarter of 2002, that restitution and other costs were estimated to be
higher than originally anticipated. As a result, during the quarter, we
reduced our medical claims payable and medical expenses by $5.0 million and
increased our estimate of accounts payable and other liabilities and
related expenses by $5.0 million.
The following are the unaudited condensed statements of operations of the
discontinued Texas HMO health care operations:
Three Months Six Months
Ended June 30, Ended June 30,
2002 2001 2002 2001
(In thousands)
Operating Revenues........................................ $ 265 $46,009 $ 3,753 $92,270
------ ------ ------ ------
Medical Expenses.......................................... (5,845) 47,376 (3,810) 87,217
General, Administrative and Marketing Expenses............ 1,592 8,076 3,647 14,582
Asset Impairment, Restructuring, Reorganization
and Other Costs........................................ 5,000 (7,800) 5,000 (7,800)
Interest Expense and Other, Net (including rental income). (482) (167) (1,084) 140
------ ------ ------ ------
Loss from Discontinued Operations Before Tax.............. - (1,476) - (1,869)
Income Tax Benefit........................................ - 494 - 626
------ ------ ------ ------
Net Loss from Discontinued Operations..................... $ - $ (982) $ - $(1,243)
====== ====== ====== ======
The table below presents a summary of discontinued Texas HMO health care
operations' asset impairment, restructuring, reorganization and other cost
activity for the periods indicated. These expenses are included in general,
administrative and marketing expenses of the discontinued operations.
Restructuring Premium
Asset and Deficiency
Impairment Reorganization Maintenance Other Total
(In thousands)
Balance, January 1, 2001........ - $ 3,755 $ 9,278 $ 800 $13,833
Charges recorded................ $ 1,600 4,380 570 6,550
Cash used....................... (3,716) (1,478) (800) (5,994)
Noncash activity................ (1,600) (125) (1,725)
Changes in estimate............. (7,800) (7,800)
------ ------ ------ ----- ------
Balance, December 31, 2001...... - 4,294 570 - 4,864
Charges recorded................
Cash used....................... (1,549) (446) (1,995)
Noncash activity................
Changes in estimate............. 5,000 5,000
------ ------ ------- ----- ------
Balance, June 30, 2002.......... $ - $ 7,745 $ 124 $ - $ 7,869
====== ====== ======= ===== ======
The remaining restructuring and reorganization costs of $7.7 million are
primarily related to legal and restitution costs, lease and other
termination costs, the cost to provide malpractice insurance on our
discontinued affiliated medical groups and various other exit related
costs. Management believes that the remaining reserves, as of June 30,
2002, are appropriate and that no further revisions to the estimates are
necessary at this time. Based on the current estimated Texas HMO healthcare
run-out costs and recorded reserves, we believe we have adequate funds
available and the ability to fund the anticipated obligations.
The following are the unaudited assets and liabilities of the discontinued
Texas health care operations:
June 30, December 31,
2002 2001
(In thousands)
ASSETS
Cash and Cash Equivalents.............................. $ - $ -
Accounts Receivable, Net............................... 2 1,402
Other Assets........................................... 4,744 6,895
Property and Equipment, Net............................ 19,817 20,107
------- -------
ASSETS OF DISCONTINUED OPERATIONS....................... 24,563 28,404
------- -------
LIABILITIES
Accounts Payable and Other Liabilities................. 15,441 16,407
Medical Claims Payable................................. 8,364 36,567
Unearned Premium Revenue............................... - 68
Premium Deficiency Reserve............................. 124 1,700
Mortgage Loan Payable.................................. 29,189 29,189
------- -------
LIABILITIES OF DISCONTINUED OPERATIONS.................. 53,118 83,931
------- -------
NET LIABILITIES OF DISCONTINUED OPERATIONS.............. $(28,555) $(55,527)
======= =======
The assets and liabilities above do not include an intercompany liability
of $27.0 million from Texas Health Choice, L.C., ("TXHC") to Sierra at June
30, 2002. The liability is secured by certain of the TXHC land and
buildings and has been eliminated upon consolidation.
Property and equipment consists mainly of real estate properties located in
the Dallas/Fort Worth metroplex areas. TXHC acquired these properties from
Kaiser Foundation Health Plan of Texas ("Kaiser-Texas"), for $44.0 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
Texas HMO health care operations, the Company announced its intention to
sell these properties. The real estate was written down to its estimated
fair value and the Company took an asset impairment charge of $27.0
million. The real estate is encumbered by a mortgage loan to Kaiser-Texas,
which is guaranteed by Sierra.
During 2001, Sierra participated in negotiations with Kaiser-Texas relating
to the real estate properties and associated mortgage loan to Kaiser-Texas
along with other matters. Sierra reached an agreement with Kaiser-Texas,
effective December 31, 2001, whereby Kaiser-Texas forgave $8.5 million of
the outstanding principal balance of the mortgage loan and extended the
maturity from November 1, 2003 to November 1, 2006. In exchange for the
consideration by Kaiser-Texas, Sierra agreed to an unconditional guaranty
of the mortgage loan. In conjunction with the agreement, Sierra applied a
$2.5 million outstanding receivable from Kaiser-Texas to the outstanding
balance of the mortgage loan on December 31, 2001.
In accordance with accounting principles generally accepted in the United
States of America, the agreement was accounted for as a restructuring of
debt. In the transaction, total future cash payments (interest and
principal) were less than the balance of the mortgage loan at the time of
the agreement. Accordingly, a gain on restructuring was recognized for the
difference and the carrying amount of the mortgage loan is equal to the
total future cash payments. Costs incurred in connection with the agreement
were offset against the gain on restructuring. At June 30, 2002, the
mortgage loan has a carrying value of $29.2 million, which consists of a
principal balance of $22.7 million and $6.5 million in future accrued
interest. Effective January 1, 2002, all future cash payments, including
interest, related to the mortgage loan are reductions of the carrying
amount; therefore, no future interest expense will be recognized. The
transaction resulted in an immaterial gain.
4. Earnings Per Share:
The following table provides a reconciliation of basic and diluted earnings
per share ("EPS") for continuing operations:
Dilutive
Basic Stock Options Diluted
(In thousands, except per share data)
For the Three Months ended June 30, 2002:
Income from Continuing Operations $10,523 $10,523
Shares 28,207 2,692 30,899
Per Share Amount $.37 $.34
For the Three Months ended June 30, 2001:
Income from Continuing Operations $ 3,777 $ 3,777
Shares 27,515 487 28,002
Per Share Amount $.14 $.13
For the Six Months ended June 30, 2002:
Income from Continuing Operations $17,904 $17,904
Shares 28,146 2,383 30,529
Per Share Amount $.64 $.59
For the Six Months ended June 30, 2001:
Income from Continuing Operations $ 7,243 $ 7,243
Shares 27,501 394 27,895
Per Share Amount $.26 $.26
5. The following table presents comprehensive income for the periods
indicated:
Three Months Ended June 30, Six Months Ended June 30,
2002 2001 2002 2001
(In thousands)
Net Income.................................. $10,523 $ 2,795 $17,904 $ 6,000
Change in Accumulated Other
Comprehensive Income (Loss), Net.......... 4,195 (2,558) 1,112 (1,589)
------ ------- ------ ------
Comprehensive Income........................ $14,718 $ 237 $19,016 $ 4,411
====== ======= ====== ======
6. Sale-Leaseback
On December 28, 2000, the Company sold the majority of its Las Vegas,
Nevada administrative and medical clinic real estate holdings in a
sale-leaseback transaction. Due to continuing involvement as defined in
Statement of Financial Accounting Standards No. 98, "Accounting for Leases"
("SFAS No. 98"), the transaction did not qualify as a sale. The Company
recorded the transaction as a financing obligation offset by the mortgage
notes receivable.
During 2001, the Company received full payment on the outstanding mortgage
notes receivable associated with three of the medical clinics. During the
first quarter of 2002, the Company received the deposit back on the three
administrative buildings. During the second quarter of 2002, the Company
received full payment on the outstanding mortgage note receivable
associated with one of the remaining medical clinics. The receipt of funds
cured the continuing involvement criteria from SFAS No. 98 and the
associated buildings then qualified as a sale. To record the sale, the
Company retired the assets and their associated accumulated depreciation
and financing obligation and recorded a deferred gain to be recognized over
the remaining 14 year term of the lease. The impact of the sale of the
buildings recorded during 2002 was a net reduction of $47.7 million in
property and equipment, a net reduction of $58.1 million in the associated
financing obligation and a deferred gain of $10.3 million. As of June 30,
2002, the remaining financing obligation was $16.8 ($31.9 million offset by
mortgage notes receivable of $15.1 million).
The Company expects that the remaining mortgages and deposits will be
repaid to Sierra before the end of 2002, at which time the remaining
medical clinics will qualify as a sale.
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 health care 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 also provides third party administrative services.
The Company evaluates each segment's performance based on segment operating
profit. Information concerning reportable segments for continuing
operations is as follows:
Managed Care Military Workers'
and Corporate Health Services Compensation
Operations Operations Operations Total
(In thousands)
Three Months Ended June 30, 2002
Medical Premiums.......................... $211,408 $211,408
Military Contract Revenues................ $ 93,740 93,740
Specialty Product Revenues................ 2,012 $44,268 46,280
Professional Fees......................... 7,704 7,704
Investment and Other Revenues............. 525 626 3,685 4,836
------- ------- ------ -------
Total Revenue.......................... $221,649 $ 94,366 $47,953 $363,968
======= ======== ====== =======
Segment Operating Profit.................. $ 12,306 $ 4,504 $ 967 $ 17,777
Interest Expense and Other, Net........... (1,608) (13) (332) (1,953)
------- ------- ------ -------
Income Before Income Taxes................ $ 10,698 $ 4,491 $ 635 $ 15,824
======= ======= ====== =======
Three Months Ended June 30, 2001
Medical Premiums.......................... $172,402 $172,402
Military Contract Revenues................ $ 88,086 88,086
Specialty Product Revenues................ 1,933 $42,968 44,901
Professional Fees......................... 7,746 7,746
Investment and Other Revenues............. 688 641 3,863 5,192
------- ------- ------ -------
Total Revenue.......................... $182,769 $ 88,727 $46,831 $318,327
======= ======= ====== =======
Segment Operating Profit.................. $ 6,631 $ 2,394 $ 2,366 $ 11,391
Interest Expense and Other, Net........... (5,828) 116 (5,712)
------- ------- -------- -------
Income Before Income Taxes................ $ 803 $ 2,394 $ 2,482 $ 5,679
======= ======= ====== =======
Six Months Ended June 30, 2002
Medical Premiums.......................... $418,052 $418,052
Military Contract Revenues................ $179,194 179,194
Specialty Product Revenues................ 3,963 $86,414 90,377
Professional Fees......................... 15,226 15,226
Investment and Other Revenues............. 1,069 1,085 7,545 9,699
------- ------- ------ -------
Total Revenue.......................... $438,310 $180,279 $93,959 $712,548
======= ======= ====== =======
Segment Operating Profit.................. $ 21,934 $ 8,063 $ 1,756 $ 31,753
Interest Expense and Other, Net........... (4,116) (15) (699) (4,830)
------- ------- ------ -------
Income Before Income Taxes................ $ 17,818 $ 8,048 $ 1,057 $ 26,923
======= ======= ====== =======
Six Months Ended June 30, 2001
Medical Premiums.......................... $338,404 $338,404
Military Contract Revenues................ $169,998 169,998
Specialty Product Revenues................ 3,905 $82,422 86,327
Professional Fees......................... 15,075 15,075
Investment and Other Revenues............. 2,212 1,162 8,377 11,751
------- ------- ------ -------
Total Revenue.......................... $359,596 $171,160 $90,799 $621,555
======= ======= ====== =======
Segment Operating Profit.................. $ 13,361 $ 4,389 $ 3,703 $ 21,453
Interest Expense and Other, Net........... (9,782) (17) (763) (10,562)
------- ------- ------ -------
Income Before Income Taxes................ $ 3,579 $ 4,372 $ 2,940 $ 10,891
======= ======= ======= =======
Goodwill expense of $204,000 and $405,000 is included as part of the managed
care and corporate operations segment for the three and six months ended June
30, 2001, respectively.
8. CII Financial Debentures
In December 2000, CII Financial, our wholly-owned workers' compensation
subsidiary, commenced an offer to exchange its outstanding 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 remaining $5.0 million in
subordinated debentures were paid at maturity. Since the time of the
exchange, Sierra has purchased $1.0 million in outstanding 9 1/2% senior
debentures which are eliminated upon consolidation.
The transaction was accounted for as a restructuring of debt, therefore all
future cash payments, including interest, related to the debentures will be
reductions of the carrying amount of the debentures and no future interest
expense will be recognized. Accordingly, the 9 1/2% senior debentures have
a carrying amount of $17.5 million, which consists of principal amount of
$14.0 million and $3.5 million in future accrued interest.
The 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 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 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 (as defined), the holders of the 9 1/2% senior debentures may
require that CII Financial repurchase them at the then applicable
redemption price, plus accrued and unpaid interest.
9. Goodwill
On January 1, 2002 the Company adopted Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142").
SFAS No. 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 No. 142 also required the
Company to complete a transitional goodwill impairment test six months from
the date of adoption and at least annually thereafter. The net amortized
goodwill balance at December 31, 2001 was $14.8 million. The Company has
completed its transitional goodwill test and determined that the recorded
goodwill was not impaired under the guidelines of the pronouncement.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the results of our operations as though the
adoption of SFAS No. 142 occurred as of January 1, 2001:
Three Months Ended June 30, 2001
As Reported Adjustments As Adjusted
(In thousands, except per share data)
Net Income from Continuing Operations................... $3,777 $132 $3,909
Loss from Discontinued Operations....................... (982) - (982)
----- --- -----
Net Income...................................... $2,795 $132 $2,927
===== === =====
Earnings per Common Share:
-------------------------
Net Income from Continuing Operations................... $ .14 - $ .14
Loss from Discontinued Operations....................... (.04) - (.04)
---- --- ----
Net Income...................................... $ .10 - $ .10
==== === ====
Earnings per Common Share Assuming Dilution:
-------------------------------------------
Net Income from Continuing Operations................... $ .13 - $ .13
Loss from Discontinued Operations....................... (.03) - (.03)
---- --- ----
Net Income...................................... $ .10 - $ .10
==== === ====
Six Months Ended June 30, 2001
As Reported Adjustments As Adjusted
(In thousands, except per share data)
Net Income from Continuing Operations................... $ 7,243 $263 $ 7,506
Loss from Discontinued Operations....................... (1,243) - (1,243)
------ --- ------
Net Income...................................... $ 6,000 $263 $ 6,263
====== === ======
Earnings per Common Share:
-------------------------
Net Income from Continuing Operations................... $ .26 $.01 $ .27
Loss from Discontinued Operations....................... (.04) - (.04)
---- --- ----
Net Income...................................... $ .22 $.01 $ .23
==== === ====
Earnings per Common Share Assuming Dilution:
-------------------------------------------
Net Income from Continuing Operations................... $ .26 $.01 $ .27
Loss from Discontinued Operations....................... (.04) - (.04)
---- --- ----
Net Income...................................... $ .22 $.01 $ .23
==== === ====
10. Recent Accounting Pronouncements
In October 2001, the FASB issued SFAS No. 144, which is effective for
fiscal years beginning after December 15, 2001 with early adoption
recommended. As described in Note 3 above, Sierra elected to early adopt
SFAS No. 144 effective January 1, 2001. 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.
In April 2002, the FASB issued Statement of Financial Accounting Standard
No. 145, "Recission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" ("SFAS No. 145"). SFAS No. 145
requires that gains and losses from extinguishment of debt be classified as
extraordinary items only if they meet the criteria in Accounting Principles
Board Opinion No. 30 ("Opinion No. 30"). Applying the provisions of Opinion
No. 30 will distinguish transactions that are part of an entity's recurring
operations from those that are unusual and infrequent that meet the
criteria for classification as an extraordinary item. SFAS No. 145 is
effective for the Company beginning January 1, 2003, but the Company may
adopt the provisions of SFAS No. 145 prior to this date. The Company has
not yet evaluated the impact from SFAS No. 145 on its financial position
and results of operations.
In June 2002, the FASB issued Statement of Financial Accounting Standard
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities"
("SFAS No. 146"). SFAS No. 146 addresses financial accounting and reporting
for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)". SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. A fundamental
conclusion reached by the FASB in this statement is that an entity's
commitment to a plan, by itself, does not create a present obligation to
others that meets the definition of a liability. SFAS No. 146 also
establishes that fair value is the objective for initial measurement of the
liability. The provisions of this statement are effective for exit or
disposal activities that are initiated after December 31, 2002, with early
adoption encouraged. The Company has not yet evaluated the impact from SFAS
No. 146 on its financial position and results of operations.
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 our audited Consolidated Financial Statements and accompanying
notes for the year ended December 31, 2001 and "Management Discussion and
Analysis of Financial Condition and Results of Operations" included in our 2001
annual report on Form 10-K filed with the Securities and Exchange Commission on
March 29, 2002, and in conjunction with our unaudited Condensed Consolidated
Financial Statements and accompanying notes for the three and six month periods
ended June 30, 2002 and 2001 included in this Form 10-Q. The information
contained below is subject to risk factors. We urge you to review carefully the
section "Risk Factors" in our 2001 Form 10-K for a more complete discussion of
the risks associated with an investment in our securities. See "Note on
Forward-Looking Statements and Risk Factors" under Item 1 of our 2001 Form 10-K.
This report contains "forward-looking statements" within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, both as amended. All statements other than statements of historical
fact are forward-looking statements for purposes of federal and state securities
laws. The cautionary statements are made pursuant to the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, as amended,
and identify important factors that could cause our actual results to differ
materially from those expressed in any projected, estimated or forward-looking
statements relating to us. These forward-looking statements are identified by
their use of terms and phrases such as "anticipate," "believe," "continue,"
"could," "estimate," "expect," "intend," "may," "plan," "project," "will" and
other similar terms and phrases, including references to assumptions.
Although we believe that the expectations reflected in any of our
forward-looking statements are reasonable, actual results could differ
materially from those projected or assumed in any of our forward-looking
statements. Readers are cautioned not to place undue reliance on these
forward-looking statements that speak only as of the date hereof. We undertake
no obligation to republish revised forward-looking statements to reflect events
or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
Critical Accounting Policies and Estimates
In preparing our consolidated financial statements, we are required to make
judgments, assumptions and estimates which affect certain of our revenues and
expenses, their related balance sheet accounts and our disclosure of our
contingent assets and liabilities. Our most significant accounting estimates are
the liability for medical claims payable, reserve for losses and loss adjustment
expense, or LAE and reinsurance recoverables. Due to the inherent uncertainty in
projecting these estimates, it is not only possible but probable that there will
be differences between the projections and the actual results. Any subsequent
change in an estimate for a prior period would be reflected in the current
period's operating results. For a description of our other critical accounting
policies and estimates, see Item 7 of our 2001 Form 10-K and for a more
extensive discussion of our accounting policies, see Note 2, Summary of
Significant Accounting Policies, in the Notes to the Consolidated Financial
Statements in our 2001 Form 10-K filed on March 29, 2002.
Our medical claims payable liability includes an estimate for pending claims and
claims incurred but not reported to us. We use a variety of actuarial projection
methods to make this estimate including historical trends and projected future
trends. Our assumptions could be affected by unanticipated legal and regulatory
changes or disputed contract provisions.
We review the adequacy of our workers' compensation insurance reserves for
losses and LAE with our independent actuary periodically. We consider external
forces such as changes in the rate of inflation, the regulatory environment, the
judicial administration of claims, medical costs and other factors that could
cause actual losses and LAE to change. The actuarial projections include a range
of estimates reflecting the uncertainty of projections over long periods of time
and are based on the anticipated ultimate cost of losses. We evaluate the
reserves in the aggregate and make adjustments where appropriate.
Reinsurance recoverable primarily represents the estimated amount of unpaid
workers' compensation loss and LAE reserves that would be recovered from our
reinsurers and, to a lesser extent, amounts billed to the reinsurers for their
portion of paid losses and LAE and health care claims. Reinsurance receivable
for ceded paid claims is recorded in accordance with the terms of the agreements
and reinsurance recoverable for unpaid losses and LAE and medical claims payable
is estimated in a manner consistent with the claim liability associated with the
reinsurance policy. Any significant changes in the underlying claim liability
could directly affect the amount of reinsurance recoverable. Reinsurance
recoverable, including amounts related to paid and unpaid losses, are reported
as assets rather than a reduction of the related liabilities. Reinsurance
contracts do not relieve us from our obligations to enrollees, injured workers
or policyholders. If our reinsurers were to fail to honor their obligations
because of insolvency or disputed contract provisions, we could incur
significant losses. We evaluate the financial condition of our reinsurers to
minimize our exposure to significant losses from reinsurer insolvencies.
RESULTS OF OPERATIONS, THREE MONTHS ENDED JUNE 30, 2002, COMPARED TO THREE
MONTHS ENDED JUNE 30, 2001.
Total Operating Revenues increased approximately 14.3% to $364.0 million from
$318.3 million for 2001.
Medical Premiums from our HMO and managed indemnity insurance subsidiaries
increased $39.0 million or 22.6%. The $39.0 million increase in premium revenue
reflects a 5.3% increase in Medicare member months (the number of months
individuals are enrolled in a plan) and a 28.7% increase in commercial member
months. The growth in Medicare member months contributes significantly to the
increase in premium revenues as the Medicare per member premium rates are over
three times higher than the average commercial premium rate.
HMO premium rates for renewing commercial groups increased on average 9% to 12%
while the overall rate increase, including continuing business and new members,
resulted in an approximate 6.5% increase. Managed indemnity rates increased
approximately 16.3%. The basic Medicare rate increase received for the Las Vegas
area was approximately 2%. Our overall Medicare rate increase was approximately
6.5% due primarily to the following:
o An increase in the Social HMO membership as a percentage of our total
Medicare membership. The Social HMO members have a higher average rate
then our other Medicare members. Over 97% of our Las Vegas, Nevada
Medicare members are enrolled in the Social HMO Medicare program.
o We experienced increased risk factors in our membership which
contributes to higher rates and corresponding medical expenses.
o We received rate increases in excess of 2% for membership outside of
the Las Vegas area.
The Centers for Medicare and Medicaid Services, or CMS, formerly known as the
Health Care Financing Administration, or HCFA, may consider adjusting the
reimbursement factor or changing the program for the Social HMO members in the
future. If the reimbursement for these members decreases significantly and
related benefit changes are not made in a timely manner, there could be a
material adverse effect on our business. Continued medical premium revenue
growth is principally dependent upon continued enrollment in our products and
upon competitive and regulatory factors.
Military Contract Revenues increased $5.7 million or 6.4%. The increase in
revenue is primarily the result of additive change order work and is
significantly offset by increased military contract expenses associated with
those change orders. The Congressionally approved Department of Defense, or DoD,
fiscal year 2001 budget included several sweeping changes to the TRICARE
program. In April 2001, Sierra Military Health Services, Inc., or SMHS, began
implementation of a prescription drug program for beneficiaries over age 65.
Likewise, in October 2001, SMHS implemented TRICARE for Life which is a
comprehensive health care benefit to those retired military beneficiaries over
age 65. Both of these program modifications resulted from Congressional changes
to the program. SMHS administers the expanded benefits only to the over age 65
retiree military population. SMHS does not directly fund claims payment or bear
any risk for the actual level of health care service utilization and does not
record any claims payments or related revenue on these programs.
In June 2002, SMHS began the fifth year of a five year contract with the DoD.
The DoD has extended expiring TRICARE contracts in other regions and SMHS is in
negotiations with the DoD about a possible extension to the base contract. If
SMHS is unsuccessful in negotiating a contract extension, its contract will end
on May 31, 2003 with an eight month phase out of services. The DoD has released
a request for proposal for the procurement and subsequent award of three TRICARE
managed care support contracts in place of the current seven contracts. A
request for proposal was issued on August 1, 2002 and we are currently
evaluating it. If the DoD were to reduce the number of contracts from seven to
three and we were not able to obtain one of the three new contracts, there would
be a material adverse effect on our business.
Specialty Product Revenues increased $1.4 million or 3.1%. The revenue increase
was from the workers' compensation insurance segment as administrative services
revenue remained consistent between the quarters.
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 from $45.2 million in 2001 to
$41.8 million in 2002 or 7.6% due primarily to a 27.0% decrease in premium
production that was partially offset by a 26.2% increase in composite premium
rates. Ceded reinsurance premiums decreased by $2.2 million due to the
expiration of our low level reinsurance agreement on June 30, 2000 and a new
reinsurance agreement with lower ceded premiums. In addition, we recorded an
adjustment of our estimate of historical ceded premiums related to the low level
agreement which further reduced our ceded reinsurance premiums by $2.0 million.
Professional Fees were consistent with 2001 at $7.7 million for the quarter.
Investment and Other Revenues decreased $400,000 or 6.9% due primarily to a
decrease in the average investment yield during the period offset by an increase
in the average invested balance.
Medical Expenses increased $30.5 million or 21.0% due primarily to our increased
membership. Medical expenses as a percentage of medical premiums and
professional fees decreased to 80.4% from 80.8%. The decrease is primarily due
to premium yields in excess of cost increases. Our medical claims payable
liability requires us to make estimates. See the discussion of our medical
claims payable liability under critical accounting policies and estimates for a
further explanation.
Military Contract Expenses increased $3.5 million or 4.1%. 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 639,000
dependents of active duty military personnel and military retirees under the age
of 65 and their dependents through a network of nearly 50,000 health care
providers and certain other subcontractor partnerships. 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 $2.6 million or 5.7%. Expenses increased in
the workers' compensation operations by approximately $2.5 million and by
$100,000 in administrative services expense.
The increase in the workers' compensation insurance segment expenses is
primarily due to the following:
o Approximately $900,000 in additional loss and LAE related to the increase
in net earned premiums in 2002 compared to 2001.
o In 2002, we recorded $3.2 million of net adverse loss development for prior
accident years compared to net adverse loss development of $4.2 million
recorded in 2001. The net adverse loss 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 in the past few periods and this trend may
continue.
o The loss and LAE ratio for the 2002 accident year was higher due to the
termination of the low level reinsurance agreement offset by significant
premium increases. The higher loss and LAE ratio resulted in an increase in
expense of approximately $1.3 million. The low level reinsurance agreement
terminated on June 30, 2000 which resulted 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 $1.3 million related primarily to
the increase in net earned premiums.
Since 1999, we have experienced adverse loss development on prior accident
years. Loss reserves are evaluated periodically and due to the inherent
uncertainty in projecting loss reserves, it is possible that we may continue to
experience adverse development in the foreseeable future. Our reserve for losses
and LAE requires us to make estimates. See the discussion of our reserves for
losses and LAE under critical accounting policies and estimates for a further
explanation.
The net adverse loss development on prior accident years included those years
that were covered by our low level reinsurance agreement. This resulted in an
increase in the reinsurance recoverable balance which is then reduced by amounts
collected from reinsurers. Net reinsurance recoverable decreased by $1.1 million
in the quarter compared to an increase of $11.6 million in the second quarter of
2001. The $1.1 million decrease in the second quarter of 2002 consisted of cash
received from our reinsurers of $11.7 million, which was largely offset by an
increase in ceded reserves of $10.6 million.
In February 2002, California enacted Assembly Bill 749. This new legislation
will increase benefits paid to injured workers starting January 1, 2003. The
Workers' Compensation Insurance Rating Bureau of California, or WCIRB, has
estimated that the new legislation will increase the loss costs for 2003
policies by approximately 9.7%. Increased loss costs, such as benefit increases,
are normally built into the rating-making process so that premiums are increased
to cover the increase in costs. Although we intend to increase our premiums,
there is no assurance that our increase will be sufficient enough to cover the
estimated costs increases or that the WCIRB's estimate is accurate.
Reinsurance contracts do not relieve us from our obligations to enrollees or
policyholders. At June 30, 2002, we had over $200 million in reinsurance
recoverable. We evaluate the financial condition of our reinsurers to minimize
our exposure to significant losses from reinsurer insolvencies. At June 30,
2002, all of our reinsurers were rated A+ or better by Fitch Ratings and the
A.M. Best Company. Should these companies be unable to perform their obligations
to reimburse us for ceded losses, we would experience significant losses.
The combined ratio is a measurement of the workers' compensation 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 107.4% compared to
103.9% for 2001. The increase was primarily due to increased underwriting
expenses.
General, Administrative and Marketing Expenses, or G&A, increased $2.6 million
or 8.9%. The primary increases in G&A expenses were payroll and benefits,
brokers fees, which were primarily due to the growth in premium revenues, and
legal costs. As a percentage of revenues, G&A expenses were 8.8% compared to
9.3% in 2001. As a percentage of medical premium revenue, G&A expenses were
15.2% for 2002 compared to 17.1% for 2001. Our general and administrative
buildings associated with the sale-leaseback transaction qualified as a sale at
the end of the first quarter of 2002. This resulted in a quarterly increase in
G&A expenses of approximately $1.1 million and a corresponding decrease in
interest expense. See Note 6 of the Notes to Condensed Consolidated Financial
Statements for a further explanation of the sale-leaseback transaction.
Interest Expense and Other, Net decreased $3.8 million or 65.8%. Interest
expense related to the revolving credit facility decreased $700,000 due to a
decrease in the average balance of outstanding debt during the period and a
decrease in the weighted average cost of borrowing. Our average interest rate on
the revolving credit facility, excluding the amortization of deferred financing
fees, our interest rate swap agreement and fees on the unused portion of the
credit facility was 4.4% in 2002 compared to 8.6% in 2001. We incur a fee of
0.5% on the unused portion of the revolving credit facility. In addition, we are
amortizing $300,000 per quarter of deferred financing fees.
Interest expense related to the sale-leaseback transaction decreased by $1.4
million as more buildings qualified as a sale at the end of the first quarter of
2002. We expect the remainder of the medical clinics to qualify as a sale before
the end of 2002. This will result in an increase in medical expenses of
approximately $600,000 per quarter and a decrease in interest expense of
approximately $700,000. See Note 6 of the Notes to Condensed Consolidated
Financial Statements for a further explanation of the sale-leaseback
transaction.
CII Financial debenture interest decreased by $300,000 in 2002, as a result of
the restructuring of the debentures, which occurred during the second quarter of
2001 when we recorded a net gain of $700,000 on the transaction. In addition, we
had a net loss on sale of assets of $200,000 in 2002 compared to $2.4 million in
2001.
Provision for Income Taxes was recorded at $5.3 million for 2002 compared to
$1.9 million for 2001. The effective tax rate for both periods was 33.5%. Our
ongoing effective tax rate is less than the statutory rate due primarily to tax
preferred investments.
Discontinued Operations consist entirely of our Texas HMO health care
operations. See Note 3 of the Notes to Condensed Consolidated Financial
Statements. We elected to adopt early Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets", or SFAS No. 144, effective January 1, 2001. In the third quarter of
2001, we decided to exit the Texas HMO health care market and received approval
from the Texas Department of Insurance in mid-October 2001. We ceased providing
HMO health care coverage on April 17, 2002. In accordance with SFAS No. 144, our
Texas HMO health care operations are now reclassified as a discontinued
operation. The net loss from discontinued operations was $0 and $1.0 million for
the second quarter of 2002 and 2001, respectively. The utilization of prior
premium deficiency reserves were $800,000 in 2002 and $6.0 million in 2001.
RESULTS OF OPERATIONS, SIX MONTHS ENDED JUNE 30, 2002, COMPARED TO SIX MONTHS
ENDED JUNE 30, 2001.
Total Operating Revenues increased approximately 14.6% to $712.5 million from
$621.6 million for 2001.
Medical Premiums from our HMO and managed indemnity insurance subsidiaries
increased $79.6 million or 23.5%. The $79.6 million increase in premium revenue
reflects a 5.5% increase in Medicare member months (the number of months
individuals are enrolled in a plan) and a 29.8% increase in commercial member
months. The growth in Medicare member months contributes significantly to the
increase in premium revenues as the Medicare per member premium rates are over
three times higher than the average commercial premium rate.
HMO premium rates for renewing commercial groups increased on average 9% to 12%
while the overall rate increase, including continuing business and new members,
resulted in an approximate 7.4% increase. Managed indemnity rates increased
approximately 16.5%. The basic Medicare rate increase received for the Las Vegas
area was approximately 2%. Our overall Medicare rate increase was approximately
6.3% due primarily to the following:
o An increase in the Social HMO membership as a percentage of our total
Medicare membership. The Social HMO members have a higher average rate
then our other Medicare members. Over 97% of our Las Vegas, Nevada
Medicare members are enrolled in the Social HMO Medicare program.
o We experienced increased risk factors in our membership which
contributes to higher rates and corresponding medical expenses.
o We received rate increases in excess of 2% for membership outside of
the Las Vegas area.
The Centers for Medicare and Medicaid Services, or CMS, formerly known as the
Health Care Financing Administration, or HCFA, may consider adjusting the
reimbursement factor or changing the program for the Social HMO members in the
future. If the reimbursement for these members decreases significantly and
related benefit changes are not made in a timely manner, there could be a
material adverse effect on our business. Continued medical premium revenue
growth is principally dependent upon continued enrollment in our products and
upon competitive and regulatory factors.
Military Contract Revenues increased $9.2 million or 5.4%. The increase in
revenue is primarily the result of additive change order work and is
significantly offset by increased military contract expenses associated with
those change orders. The Congressionally approved Department of Defense, or DoD,
fiscal year 2001 budget included several sweeping changes to the TRICARE
program. In April 2001, SMHS began implementation of a prescription drug program
for beneficiaries over age 65. Likewise, in October 2001, SMHS implemented
TRICARE for Life which is a comprehensive health care benefit to those retired
military beneficiaries over age 65. Both of these program modifications resulted
from Congressional changes to the program. SMHS administers the expanded
benefits only to the over age 65 retiree military population. SMHS does not
directly fund claims payment or bear any risk for the actual level of health
care service utilization and does not record any claims payments or related
revenue on these programs.
Specialty Product Revenues increased $4.0 million or 4.7%. The revenue increase
was from the workers' compensation insurance segment as administrative services
revenue remained consistent between the periods.
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 from $95.5 million in 2001 to
$86.3 million in 2002 or 9.6% due primarily to a 26.7% decrease in premium
production that was partially offset by a 24.1% increase in composite premium
rates. Ceded reinsurance premiums decreased by 108.5% due to the expiration of
our low level reinsurance agreement on June 30, 2000 and a new reinsurance
agreement with lower ceded premiums. In addition, we recorded an adjustment of
our estimate of historical ceded premiums related to the low level agreement
which further reduced our ceded reinsurance by $2.0 million.
Professional Fees increased $200,000 or 1.0% as a result of increased
membership.
Investment and Other Revenues decreased $2.1 million or 17.5% due primarily to a
decrease in the average investment yield during the period offset by an increase
in the average invested balance.
Medical Expenses increased $64.2 million or 22.3% due primarily to our increased
membership. Medical expenses as a percentage of medical premiums and
professional fees decreased to 81.1% from 81.3%. The decrease is primarily due
to premium yields in excess of cost increases which were partially offset by
higher bed days in 2002. Our medical claims payable liability requires us to
make estimates. See the discussion of our medical claims payable liability under
critical accounting policies and estimates for a further explanation.
Military Contract Expenses increased $5.4 million or 3.3%. 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 639,000
dependents of active duty military personnel and military retirees under the age
of 65 and their dependents through a network of nearly 50,000 health care
providers and certain other subcontractor partnerships. 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 $5.0 million or 5.6%. Expenses increased in
the workers' compensation operations by approximately $5.1 million which was
offset by a slight decrease in administrative services expense of $100,000.
The increase in the workers' compensation insurance segment expenses is
primarily due to the following:
o Approximately $2.9 million in additional loss and LAE related to the
increase in net earned premiums in 2002 compared to 2001.
o In 2002, we recorded $5.3 million of net adverse loss development for prior
accident years compared to net adverse loss development of $5.8 million
recorded in 2001. The net adverse loss 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 in the past few periods and this trend may
continue.
o The loss and LAE ratio for the 2002 accident year was slightly higher due
to the termination of the low level reinsurance agreement offset by
significant premium increases. The higher loss and LAE ratio resulted in an
increase in expense of approximately $100,000. The low level reinsurance
agreement terminated on June 30, 2000, which resulted 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 $2.6 million related primarily to the increase in net
earned premiums.
Since 1999, we have experienced adverse loss development on prior accident
years. Loss reserves are evaluated periodically and due to the inherent
uncertainty in projecting loss reserves, it is possible that we may continue to
experience adverse development in the foreseeable future. Our reserve for losses
and LAE requires us to make estimates. See the discussion of our reserves for
losses and LAE under critical accounting policies and estimates for a further
explanation.
The net adverse loss development on prior accident years included those years
that were covered by our low level reinsurance agreement. This resulted in an
increase in the reinsurance recoverable balance which is then reduced by amounts
collected from reinsurers. Net reinsurance recoverable decreased by $18.0
million in 2002 compared to an increase of $10.6 million in 2001. The $18.0
million decrease in 2002 consisted of cash received from our reinsurers of $38.8
million, which was largely offset by an increase in ceded reserves of $20.8
million.
The combined ratio is a measurement of the workers' compensation 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 107.0% compared to
106.3% for 2001. The increase was primarily due to increased underwriting
expenses. Excluding adverse loss development, the combined ratio would have been
100.8% for 2002 and 99.2% for 2001.
General, Administrative and Marketing Expenses, or G&A, increased $6.1 million
or 10.8%. The primary increases in G&A expenses were payroll and benefits,
brokers fees, which were primarily due to increased premium revenues, general
insurance costs and lease expense. The increase in lease expense is a result of
the sale-leaseback transaction on our administrative buildings qualifying as a
sale at the end of the first quarter of 2002. As a result, future lease payments
are treated as an operating lease versus the previous treatment which was
similar to a capital lease. The impact of this change is a quarterly increase in
G&A expenses of approximately $1.1 million and a corresponding decrease in
interest expense. See Note 6 of the Notes to Condensed Consolidated Financial
Statements for a further explanation of the sale-leaseback transaction. As a
percentage of revenues, G&A expenses were 8.8% compared to 9.1% in 2001. As a
percentage of medical premium revenue, G&A expenses were 15.0% for 2002 compared
to 16.7% for 2001.
Interest Expense and Other, Net decreased $5.7 million or 54.3%. Interest
expense related to the revolving credit facility decreased $2.1 million due to a
decrease in the average balance of outstanding debt during the period and a
decrease in the weighted average cost of borrowing. Our average interest rate on
the revolving credit facility, excluding the amortization of deferred financing
fees, our interest rate swap agreement and fees on the unused portion of the
credit facility was 5.0% in 2002 compared to 9.2% in 2001. We incur a fee of
0.5% on the unused portion of the revolving credit facility. In addition, we are
amortizing $300,000 per quarter of deferred financing fees.
Interest expense related to the sale-leaseback transaction decreased by $1.6
million as more buildings qualified as a sale at the end of the first quarter of
2002. CII Financial debenture interest decreased by $1.2 million in 2002, as a
result of the restructuring of the debentures, which occurred during the second
quarter of 2001 when we recorded a net gain of $700,000 on the transaction. We
had a net loss on sale of assets of $200,000 in 2002 compared to $2.4 million in
2001. In addition, we had various other increases in interest and other expense
totaling $700,000.
Provision for Income Taxes was recorded at $9.0 million for 2002 compared to
$3.6 million for 2001. The effective tax rate for both periods was 33.5%. Our
ongoing effective tax rate is less than the statutory rate due primarily to tax
preferred investments.
Discontinued Operations consist entirely of our Texas HMO health care
operations. See Note 3 of the Notes to Condensed Consolidated Financial
Statements. We elected to adopt early SFAS No. 144 effective January 1, 2001. In
the third quarter of 2001, we decided to exit the Texas HMO health care market
and received approval from the Texas Department of Insurance in mid-October
2001. We ceased providing HMO health care coverage on April 17, 2002. In
accordance with SFAS No. 144, our Texas HMO health care operations are now
reclassified as a discontinued operation. The net loss from discontinued
operations was $0 and $1.2 million for 2002 and 2001, respectively. The
utilization of prior premium deficiency reserves were $1.6 million in 2002 and
$8.3 million in 2001.
LIQUIDITY AND CAPITAL RESOURCES
For continuing operations, we had cash in-flows from operating activities of
$75.9 million in 2002 compared to $60.8 million in 2001. After adjusting for the
timing of our Medicare payment received July 1, 2002, cash in-flows for 2002
would have been $104.4 million. The improvement over 2001 is primarily
attributable to increased cash from earnings, reinsurance recoveries, an income
tax refund and an increase in medical premiums.
SMHS receives monthly cash payments equivalent to one-twelfth of its annual
contractual price with the DoD. SMHS accrues health care revenue on a monthly
basis for any monies owed above its monthly cash receipt based on the number of
at-risk eligible beneficiaries and the level of military direct care system
utilization. The contractual bid price adjustment, or BPA, process serves to
adjust the DoD's monthly payments to SMHS, because the payments are based in
part on 1996 DoD estimates for 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.
To further enhance SMHS' funding resources, on November 16, 2001, SMHS entered
into a securitization arrangement with General Electric Capital Corporation. The
arrangement provides for the sale of SMHS' Federal Government accounts
receivable to SMHS Funding, LLC. SMHS Funding is a special purpose limited
liability company owned by SMHS and was formed for the purpose of purchasing all
receivables of SMHS. This entity is fully consolidated into SMHS. SMHS Funding,
LLC may sell an undivided interest in certain of the receivables to a subsidiary
of General Electric Capital Corporation in the event that additional financing
by SMHS is warranted. This securitization arrangement has not yet been utilized
and we do not anticipate utilizing it in 2002.
For continuing operations, cash used in investing activities during 2002 was
$61.4 million compared to $8.2 million in 2001. The 2002 amount included $3.7
million in net capital expenditures compared to $1.8 million in 2001. The net
change in investments for the period was an increase in investments of $57.7
million for 2002 and $6.4 million for 2001 as investments were purchased with
cash from operations.
For continuing operations, cash used in financing activities during 2002 was
$26.5 million compared to $60.6 million in 2001. The 2002 amount included net
payments of $29.0 million on the revolving credit facility compared to net
payments of $36.0 million in 2001. Additional payments of $900,000 and $3.8
million were made on other outstanding debt and capital leases for 2002 and
2001, respectively. Additionally, $21.5 million was used in 2001 for the
purchase of CII Financial's 71/2% convertible subordinated debentures. In 2002,
we have purchased $1.0 million in outstanding CII Financial 9 1/2% senior
debentures. Proceeds from the issuance of stock were $3.4 million in 2002
compared to $700,000 in 2001.
Discontinued Texas health care operations used cash of $27.0 million in 2002
compared to $21.4 million in 2001. The cash used in 2002 was primarily for the
run out of claims offset in part by premiums collected. Based on the current
estimated Texas HMO healthcare run-out costs and recorded reserves, we believe
we have adequate funds available and the ability to invest adequate funds in
Texas to meet the anticipated obligations.
Revolving Credit Facility
Our revolving credit facility balance decreased from $89 million to $60 million
during the six month period ended June 30, 2002. The balance is reflected as
long-term debt since no portion of the outstanding balance is due in the next
twelve months. The availability under the credit facility has been reduced to
$107 million at June 30, 2002 leaving $47 million available under the credit
facility. The total availability, however, will be reduced by $6.0 million on
December 31, 2002 and by $10.0 million on June 30, 2003. The credit facility
matures on September 30, 2003. Interest under the revolving credit facility is
variable and is based on Bank of America's "prime rate" adjusted by a margin.
The current rate is 4.375%, which is a combination of the prime rate of 4.75%
less a margin of .375%. The margin can fluctuate based on our completing certain
transactions or if we fail to exceed certain financial ratios. The margin was
reduced by 1.0% on April 1, 2002 since we exceeded certain ratio requirements as
of December 31, 2001. Of the outstanding balance, $25 million is covered by an
interest-rate swap agreement. In accordance with Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities", or SFAS No. 133, we increased our recorded liability of the
interest-rate swap agreement during 2002 by $90,000.
Debentures
In December 2000, CII Financial commenced an offer to exchange its outstanding
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 remaining $5.0 million in
subordinated debentures were paid at maturity. Since the time of the exchange,
Sierra has purchased $1.0 million in outstanding 9 1/2% senior debentures which
are eliminated upon consolidation.
The transaction was accounted for as a restructuring of debt; therefore, all
future cash payments, including interest, related to the debentures will be
reductions of the carrying amount of the debentures and no future interest
expense will be recognized. Accordingly, the 9 1/2% senior debentures have a
carrying amount of $17.5 million, which consists of principal amount of $14.0
million and $3.5 million in future accrued interest.
The 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 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
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 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 is a holding company and its only significant asset is its
investment in California Indemnity. Of the $8.6 million in cash and cash
equivalents it held at June 30, 2002, approximately $8.3 million was designated
for use only by the regulated insurance companies. CII Financial has limited
sources of cash and is dependent upon dividends paid by California Indemnity.
California Indemnity may pay a dividend, without the prior approval of the state
insurance commissioner, only to the extent the cumulative amount of dividends or
distributions paid or proposed to be paid in any year does not exceed the amount
shown as unassigned funds (reduced by any unrealized gains or losses included in
any such amount) on its statutory statement as of the previous December 31. In
2002, California Indemnity can pay dividends of up to $2.1 million without the
prior approval of the state insurance commissioner. In 2002, California
Indemnity paid a dividend of $750,000 and in 2001, California Indemnity received
prior approval to pay an aggregate of $10 million in dividends. We are not in a
position to assess the likelihood of obtaining future approval for the payment
of dividends other than those specifically allowed by law in each of our
subsidiaries' state of domicile.
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 $31.3 million at June 30, 2002. 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 exit from the Texas HMO health care market, the Texas
Department of Insurance approved a plan of withdrawal and TXHC is now required
to maintain deposits and net worth of at least $3.5 million. We believe we are
in compliance with our regulatory requirements. We are limited by our credit
facility in the amount of funds we can invest in our Texas operations.
Of the $76.7 million in cash and cash equivalents held at June 30, 2002, $46.5
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 and 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.
Obligations and Commitments
The following schedule represents our obligations and commitments for long-term
debt, capital leases and operating leases. With the exception of our revolving
credit facility, the amounts below represent the entire payment, principal and
interest, on our outstanding obligations. Based on the outstanding balance of
the revolving credit facility of $60 million as of June 30, 2002, we are not
required to make any principal payments until the balance is due in 2003.
Long-Term Capital Operating
Debt Leases Leases Total
(In thousands)
Continuing Operations
Payments due within 12 months................... $ 5,287 $121 $ 14,252 $ 19,660
Payments due in 13 to 36 months................. 83,843 153 25,383 109,379
Payments due in 37 to 60 months................. 7,964 61 23,896 31,921
Payments due in more than 60 months............. 36,816 194 90,243 127,253
------- --- ------- -------
Total Continuing Operations................ $133,910 $529 $153,774 $288,213
======= === ======= =======
Discontinued Operations
Payments due within 12 months................... $235 $ 235
Payments due in 13 to 36 months................. $ 5,065 5,065
Payments due in 37 to 60 months................. 24,124 24,124
Payments due in more than 60 months............. -
------- --- -------
Total Discontinued Operations.............. $ 29,189 $235 $ 29,424
======= === =======
Included in long-term debt payments for continuing operations is $55.6 million
for our net financing obligation related to the sale-leaseback transaction. We
expect the remainder of the transaction will qualify as a sale by the end of
2002 at which time the future payments due will be categorized as operating
leases. In conjunction with the remainder of the transaction qualifying as a
sale, we will receive proceeds of $15.1 million, primarily from notes
receivable. See Note 6 of Notes to the Consolidated Financial Statements for a
more detailed discussion of the sale-leaseback transaction.
The amount included in long-term debt payments for discontinued operations is
for a mortgage loan secured by certain underlying real estate assets of the
discontinued operations. We are actively seeking a buyer for the assets and
anticipate selling within the next 12 months. As the assets are sold, we are
required to make reductions on the mortgage note and completely satisfy the
obligation once all of the assets have been sold.
Recent Accounting Pronouncements
In October 2001, the FASB issued SFAS No. 144, which is effective for fiscal
years beginning after December 15, 2001 with early adoption recommended. As
described in Note 3 above, we elected to early adopt SFAS No. 144 effective
January 1, 2001. 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.
In April 2002, the FASB issued Statement of Financial Accounting Standard No.
145, "Recission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections", or SFAS No. 145. SFAS No. 145
requires that gains and losses from extinguishment of debt be classified as
extraordinary items only if they meet the criteria in Accounting Principles
Board Opinion No. 30 ("Opinion No. 30"). Applying the provisions of Opinion No.
30 will distinguish transactions that are part of an entity's recurring
operations from those that are unusual and infrequent that meet the criteria for
classification as an extraordinary item. SFAS No. 145 is effective for us
beginning January 1, 2003, but we may adopt the provisions of SFAS No. 145 prior
to this date. We have not yet evaluated the impact from SFAS No. 145 on our
financial position and results of operations.
In June 2002, the FASB issued Statement of Financial Accounting Standard No.
146, "Accounting for Costs Associated with Exit or Disposal Activities", or SFAS
No. 146. SFAS No. 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and nullifies Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)". SFAS No. 146 requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. A fundamental conclusion reached by the FASB in this statement is that
an entity's commitment to a plan, by itself, does not create a present
obligation to others that meets the definition of a liability. SFAS No. 146 also
establishes that fair value is the objective for initial measurement of the
liability. The provisions of this statement are effective for exit or disposal
activities that are initiated after December 31, 2002, with early adoption
encouraged. We have not yet evaluated the impact from SFAS No. 146 on our
financial position and results of operations.
Other
We have a 2002 capital budget of $16.1 million and we are limited to $19.6
million by our revolving credit facility. The planned expenditures are primarily
for the purchase of computer hardware and software, furniture and equipment and
other normal capital requirements. Our liquidity needs over the next 12 months
will primarily be for the capital items noted above, debt service and funds
required to exit the Texas HMO health care market. We believe that our existing
working capital, operating cash flow and, if necessary, equipment leasing,
divestitures of certain non-core assets and amounts available under our credit
facility and securitization arrangement 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.
In the second quarter of 1997, our Board of Directors authorized a $3.0 million
loan from us to our Chief Executive Officer, or CEO. In April 2000, our Board of
Directors authorized an additional $2.5 million loan from us to the CEO. In
second quarter of 2001, our Board of Directors approved a loan amendment which
extended the maturity of the principal balance along with accrued interest to
December 31, 2003. During 2001, the CEO made payments of $898,000. No additional
payments have been made during 2002 and as of June 30, 2002 the aggregate
principal balance outstanding and accrued interest for both instruments was $5.1
million. All amounts borrowed bear interest at a rate equal to our current rate
on our revolving credit facility plus 10 basis points. The amounts outstanding
are collateralized by certain of the CEO's assets and rights to compensation
from us. The loan is pledged as collateral under our revolving credit facility.
We have a $25 million interest-rate swap agreement that allows us to mitigate
the risk of interest rate fluctuation on our credit facility. The intent of the
agreement was to keep our interest rate on $25 million of the credit facility
relatively fixed. In accordance with SFAS No. 133, we recorded the interest-rate
swap agreement to fair market value as of June 30, 2002. The fair market value
indicated that we would need to pay $775,000 to terminate the swap agreement
compared to an indicated fair market value of $685,000 at December 31, 2001. If
the prime rate were to decrease by 1%, we estimate our maximum increase in
annual expense associated with the swap to be approximately $250,000. The
agreement matures on September 23, 2003.
Membership
Number of Members at June 30,
2002 2001
Continuing Operations:
HMO
Commercial.................................................. 186,000 147,400
Medicare.................................................... 46,100 43,800
Medicaid.................................................... 29,900 19,000
Managed Indemnity............................................. 28,400 29,700
Medicare Supplement........................................... 21,000 28,100
Administrative Services....................................... 309,400 298,400
TRICARE Eligibles............................................. 639,200 642,300
--------- ---------
Total Members, Continuing Operations.......................... 1,260,000 1,208,700
========= =========
Discontinued Texas Operations:
HMO
Commercial.................................................. - 51,400
Medicare (1) ............................................... - 14,000
--------- ---------
Total Members, Discontinued Operations........................ - 65,400
========= =========
(1) The 2001 Medicare membership does not include 5,500 Houston members that
the Company ceded to AmCare Health Plans of Texas, Inc., under a
reinsurance agreement on December 1, 2000.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of June 30, 2002, unrealized holding losses on available for sale investments
have decreased by $1.1 million since 2001 due primarily to a decrease in the
yield on Government obligations and a decrease in mortgage rates. 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
Sierra held its annual meeting of stockholders on May 23, 2002 in Las
Vegas, Nevada.
The following persons were elected directors for two-year terms ending
in 2004 based on the voting results below:
Name For Withheld
Erin E. MacDonald 19,823,479 7,015,467
William J. Raggio 18,574,031 8,264,915
Charles L. Ruthe 26,406,282 432,664
Albert L. Greene 26,403,250 435,696
The following persons' terms as directors continued after the meeting
and end in 2003.
Anthony M. Marlon, M.D.
Thomas Y. Hartley
Anthony L. Watson
Michael E. Luce
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS (continued)
The stockholders also approved an amendment to the Company's Employee
Stock Purchase Plan to increase by 900,000 the number of shares of
common stock reserved for issuance to participants.
Broker
For Against Abstain Non-votes
25,328,247 1,450,516 60,183 0
The stockholders also ratified the appointment of Deloitte & Touche
LLP as the Company's independent auditors for the year ending December
31, 2002. The voting results were as follows:
Broker
For Against Abstain Non-votes
26,513,194 314,912 10,840 0
The stockholders also rejected a shareholder proposal. The voting
results were as follows:
Broker
For Against Abstain Non-votes
4,737,216 15,732,750 423,388 5,945,592
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(10.1) Amendment No. 3 to Loan Agreement dated August 11, 1997
between the Company and Anthony M. Marlon for a revolving
credit facility in the maximum aggregate amount of
$3,000,000.
(10.2) Amendment No. 1 Loan Agreement dated April 10, 2000
between the Company and Anthony M. Marlon for a term loan of
$2,500,000.
(99.1) Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(99.2) Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
Current Report on Form 8-K, dated May 1, 2002, with the
Securities and Exchange Commission in connection with the
announcement of the Company's participation in a health care
conference on May 7, 2002.
Current Report on Form 8-K, dated May 10, 2002, with the
Securities and Exchange Commission in connection with the
announcement of the Company's participation in a health care
conference on May 15, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SIERRA HEALTH SERVICES, INC.
(Registrant)
Date: August 14, 2002 /S/ Paul H. Palmer
Paul H. Palmer
Senior Vice President of Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)