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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
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
(State or other jurisdiction of
incorporation or organization)
88-0200415
(I.R.S. Employer Identification Number)
2724 NORTH TENAYA WAY
LAS VEGAS, NEVADA 89128
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (702) 242-7000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on
which registered
Common Stock, par value $.005
New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: None
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
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
The aggregate market value of the voting stock held by non-affiliates
of the registrant on March 14, 1997 was $405,166,000.
The number of shares of the registrant's common stock outstanding on March 14,
1997 was 17,865,000.
DOCUMENTS INCORPORATED BY REFERENCE
DOCUMENT WHERE INCORPORATED
Registrant's Current Report on Form 8-K dated Part I
March 28,1997. Part II, Item 7
Portions of the registrant's definitive proxy statement for Part III
its 1997 annual meeting to be filed with the SEC not later
than 120 days after the end of the fiscal year.
SIERRA HEALTH SERVICES, INC.
1996 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
Page
PART I
Item 1. Business ................................................... 1
Item 2. Properties.................................................. 14
Item 3. Legal Proceedings........................................... 14
Item 4. Submission of Matters to a Vote of Security Holders......... 14
PART II
Item 5. Market for Registrant's Common Stock and
Related Stockholder Matters.............................. 15
Item 6. Selected Financial Data..................................... 16
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operation................................. 17
Item 8. Financial Statements and Supplementary Data................. 26
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure...................... 54
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 54
Item 11. Executive Compensation...................................... 54
Item 12. Security Ownership of Certain Beneficial Owners
and Management............................................ 54
Item 13. Certain Relationships and Related Transactions.............. 54
PART IV
Item 14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K................................... 55
i
PART I
ITEM 1. BUSINESS
GENERAL
Sierra Health Services, Inc. ("Sierra") and its subsidiaries (collectively
referred to as the "Company"), is a managed health care organization that
provides and administers the delivery of comprehensive health care and workers'
compensation programs with an emphasis on quality care and cost management. The
Company's strategy has been to develop and offer a portfolio of managed health
care and workers' compensation products to employer groups and individuals. The
Company's broad range of managed health care services is provided through its
federally qualified and non-qualified health maintenance organizations ("HMOs"),
insurance companies, managed indemnity plans, a third-party administrative
services program for employer-funded health benefit plans and workers'
compensation medical management programs. Ancillary products and services that
complement the Company's managed health care and workers' compensation product
lines are also offered.
In June 1996, the Civilian Health and Medical Program of the Uniformed
Services ("CHAMPUS") granted a 5-year contract to provide health services to
Regions 7 and 8, which includes a total of 17 states, to a consortium consisting
of Sierra and 13 other health care companies. In April 1997, this consortium
will begin providing health care to approximately 700,000 individuals, of which
Sierra will be responsible for providing care to approximately 93,000
individuals in Nevada and Missouri.
In November 1996, the Company acquired the remaining ownership interests of
HMO Texas for $5.0 million. The Company had previously held a 50 percent
interest in the Houston-based health plan which had approximately 12,700 members
at the end of 1996.
Effective December 31, 1996, the Company purchased Prime Holdings, Inc.
("Prime") for approximately $31.2 million in cash. At December 31, 1996, Prime
operated MedOne Health Plan, Inc., a 12,800 member HMO, and also served 215,000
people through preferred provider organizations ("PPOs"), workers' compensation
programs and administrative services products for self-insured employers and
union welfare funds primarily in the state of Nevada.
The principal executive offices of the Company are located at 2724 North
Tenaya Way, Las Vegas, Nevada 89128, and its telephone number is (702) 242-7000.
Managed Care Products and Services
The Company's primary types of health care coverage are HMO plans, HMO
Point of Service ("POS") plans, and managed indemnity plans, which include a PPO
option. As of December 31, 1996, the Company provided HMO products to
approximately 177,000 members. Of these HMO members, approximately 92% reside in
Nevada. The POS products allow members to choose one of the various coverage
options when medical services are required instead of one plan for the entire
year. The Company also provides managed indemnity products to approximately
46,000 members, Medicare supplement products to approximately 23,000 members,
and administrative services to approximately 501,000 members, of whom a
significant portion are employees covered through workers' compensation
products. Medical premiums account for approximately 67% of total revenues, 87%
of which are derived from southern Nevada.
1
Health Maintenance Organizations. The Company operates a mixed group
network model HMO in Nevada, and a network model HMO in Texas, as well as
managed indemnity PPO plans. Most of its managed health care services in Nevada
are provided through its networks of over 1,800 providers and 17 hospitals.
These networks include the Company's multi-specialty medical group, which
provides medical services to approximately 74% of the Company's Nevada HMO
members and employs over 134 primary care and other providers in various medical
specialties. The Company directly provides home health care, hospice care and
behavioral health care services. In addition, the Company operates two 24-hour
urgent care centers, a radiology department, a vision department, an
occupational medicine department and two free-standing, state-licensed and
Medicare-approved ambulatory surgery centers. The Company believes that this
vertical integration of its health care delivery system provides a competitive
advantage as it has helped it to manage health care costs effectively while
delivering quality care. As of December 31, 1996, the Texas HMO members were
served by approximately 1,600 contracted providers and 33 hospitals. Contracted
primary care physicians and specialists for the HMOs are compensated on a
capitation or modified fee-for-service basis. Contracts with their primary
hospitals are on a capitation or discounted per diem basis. Members receive a
wide range of coverage after paying a nominal co-payment and are eligible for
preventive care coverage. The HMOs do not require deductibles, co-insurance or
claim forms.
In addition to its commercial HMO plan, which involves traditional HMO
benefits and Point of Service benefits, the Company offers prepaid health care
programs for Medicare-eligible beneficiaries called Senior Dimensions in Nevada
and Golden Choice in Texas. Senior Dimensions is marketed directly to Medicare-
eligible beneficiaries in the Company's Nevada service area. Federal legislation
has been enacted which allows delivery of health care to Medicare beneficiaries
through HMOs. Such legislation provides that the federal government will
reimburse HMOs for health care services to Medicare beneficiaries in an amount
equal to 95% of the Medicare payments to fee-for-service providers in a defined
service area. As of December 31, 1996, approximately 29,000, or 17%, of the
Company's total Nevada HMO members were enrolled in Senior Dimensions. The
Senior Dimensions plan enables Medicare beneficiaries to reduce their
out-of-pocket expenses and receive additional benefits not covered by Medicare.
In July 1996 the Company's Texas HMO received approval to offer a Medicare risk
product and by the end of the year 11% of the Company's HMO Texas members were
enrolled in Golden Choice.
Social Health Maintenance Organization. Effective November 1, 1996, the
Company entered into a three year Social HMO contract pursuant to which a large
portion of the Company's Medicare risk enrollees will receive certain expanded
benefits. The Company expects to receive additional revenues for providing these
expanded benefits. The additional revenues will be determined based on health
care assessments that will be performed on the Company's eligible Medicare risk
members. The additional benefits include, among other things, assisting the
eligible Medicare risk members with typical daily living functions such as
bathing, dressing, walking and shopping. These members, as identified in the
health care assessments, are ones who currently have difficulty performing such
daily living functions because of a health or physical problem. The additional
reimbursement will be subject to adjustment based on the number of beneficiaries
who need assistance with the social problems noted above and their individual
health care assessments. The ultimate payment received from the Health Care
Financing Administration ("HCFA") will be based on these and other factors and
is expected to exceed the current reimbursement rate from HCFA. At this time,
however, there can be no assurance as to what the final per member reimbursement
will be.
Preferred Provider Organizations. The Company also offers health insurance
through its PPO. The Company's managed indemnity plans generally offer insureds
the option of receiving their medical care from either non-contracted or
contracted providers. Insureds pay higher deductibles and co-insurance or
co-payments when they receive care from non-contracted providers. Out-of-pocket
costs are lowered by utilizing contracted providers who are part of the
Company's Nevada PPO network, consisting of approximately 3,000 providers and 32
hospitals. As of December 31, 1996, approximately 46,000 persons were enrolled
in Sierra's managed indemnity plans.
2
The Company currently provides managed indemnity and Medicare supplement
services to individuals in Nevada, Arizona, Colorado, Texas, California, New
Mexico, Missouri, and Mississippi. The Company is also exploring further
expansion in certain other states. During 1996 the Company adopted a plan to
restructure certain insurance operations to allow the Company to focus on more
favorable operating markets. This plan significantly reduced the Company's
presence in Arizona and Colorado for certain managed indemnity products.
Workers' Compensation Subsidiary. On October 31, 1995, the Company acquired
CII Financial, Inc. ("CII") for approximately $76.3 million of common stock in a
transaction accounted for as a pooling of interests. CII writes workers'
compensation insurance in the states of California, Colorado, Kansas, Nebraska,
New Mexico, Texas, and Utah. CII has licenses in 24 states and the District of
Columbia. California and Colorado represent approximately 87% and 10%,
respectively, of CII's fully insured workers' compensation insurance premiums in
1996. Workers' compensation insurance premiums account for approximately 21% of
the Company's total revenue. In conjunction with the acquisition a supplemental
indenture was filed modifying CII's 7 1/2% convertible subordinated debentures
(the "Debentures"). As a result each $1,000 in principal is now convertible into
16.921 shares of Sierra's common stock at a conversion price of $59.097 per
share.
Administrative Services. The Company's administrative services products
provide, among other things, utilization review and PPO services to large
employer groups that are usually self-insured. As of December 31, 1996,
approximately 289,000 persons were enrolled in the Company's administrative
services plans. The Company also provides workers' compensation medical
management services to employers in Nevada. As of December 31, 1996, enrollment
in this program was approximately 212,000.
Ancillary Medical Services. Among the ancillary medical services offered by
the Company are outpatient surgical care, diagnostic tests, medical and surgical
procedures, inpatient and outpatient laboratory tests, x-ray, CAT scans and
nuclear medicine services. The Company also provides home health care services,
a hospice program and mental health and substance abuse services. These services
are provided to members of the Company's HMO, managed indemnity and
administrative services plans as well as to approximately 99,000 participants
from non-affiliated employer groups and an insurance company.
Ongoing Initiatives. During 1995, the Company entered the bidding process
to provide health services for military dependents and retirees in Nevada and a
portion of Missouri. In June 1996, the Office of the Civilian Health and Medical
Program of the Uniformed Services ("OCHAMPUS") granted a 5-year contract to
provide these services to Regions 7 and 8, which includes a total of 17 states,
to a consortium consisting of Sierra and 13 other health care companies. This
consortium will begin providing health care to approximately 700,000 individuals
in April 1997 of which the Company will be providing care to approximately
93,000. In addition, the Company has submitted a proposal as the prime
contractor to CHAMPUS to provide managed health care coverage to CHAMPUS
eligible beneficiaries in Region 1. This region includes approximately 665,000
individuals in Connecticut, Delaware, Maine, Maryland, Massachusetts, New
Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Vermont, northern
Virginia and Washington, D.C. The Company expects to incur expenses of
approximately $8.0 to $10.0 million during the Region 1 contract proposal
process. The Company anticipates learning of the status of its bid in the second
quarter of 1997.
3
Marketing
The Company's marketing efforts for its commercial managed care products
involve a two-step process. The Company first makes presentations to employers
and then provides information directly to employees once the employer has
decided to offer the Company's products. Once a relationship with a group is
established and a group agreement is negotiated and signed, the Company's
marketing efforts focus on individual employees. During a designated "open
enrollment" period each year, usually the month preceding the annual renewal of
the agreement with the group, employees choose whether to remain with, join or
terminate their membership with a specific health plan offered by the employer.
New employees decide whether to join one of the employers' health insurance
options at the time of their employment. Although contracts with employers are
generally terminable on 60 days notice, changes in membership occur primarily
during open enrollment periods. Medicare risk products are primarily marketed by
the HMO's sales employees. Retention of employer groups and membership growth is
accomplished through print advertising directed to employers and through
consumer media campaigns. Media communications convey the Company's emphasis on
preventive care, ready access to health care providers and quality service.
Other communications to customers include employer and member newsletters,
member education brochures, prenatal information packets, employer/broker
seminars and direct mail advertising to clients. Members' satisfaction with
Company benefits and services is monitored by customer surveys. Results from
these surveys and other primary and secondary research guide the sales and
advertising efforts throughout the year.
The Company's workers' compensation insurance policies are sold primarily
through independent insurance agents and brokers, who may also represent other
insurance companies. The Company believes that independent insurance agents and
brokers choose to market the Company's insurance policies primarily because of
the price the Company charges. Additional considerations include the quality of
service that the Company provides and the commissions the Company pays. The
Company employs full-time employees as marketing representatives to make
personal contacts with agents and brokers, to maintain regular communication
with them, to advise them of the Company's services and products, and to recruit
additional agents and brokers. As of December 31, 1996, the Company had
relationships with approximately 420 agents and 30 brokers and paid its agents
and brokers commissions based on a percentage of the gross written premium
produced by such agents and brokers. The Company also utilizes a number of
promotional media, including advertising in publications and at trade fairs, to
support the efforts of its independent agents.
Membership
Period End Membership:
Years Ended December 31,
1996 1995 1994 1993 1992
HMO:
Commercial.............................. 147,000 116,000 107,000 89,000 82,000
Medicare................................ 30,000 25,000 20,000 15,000 14,000
Managed Indemnity........................... 46,000 31,000 24,000 30,000 30,000
Medicare Supplement......................... 23,000 15,000 9,000 4,000 2,000
Administrative Services..................... 501,000 211,000 144,000 59,000 59,000
Total Membership........................ 747,000 398,000 304,000 197,000 187,000
For the years ended December 31, 1996 and 1995, the Company received
approximately 24.2% and 23.9%, respectively, of its total revenues pursuant to
its contract with the HCFA to provide health care services to Medicare
enrollees. The Company's contract with HCFA is subject to annual renewal at the
election of HCFA and requires the Company to comply with federal HMO and
Medicare laws and
4
regulations and may be terminated if the Company fails to so comply. The
termination of the Company's contract with HCFA would have a material adverse
effect on the Company's business. In addition, there have been, and the Company
expects that there will continue to be, a number of legislative proposals to
limit Medicare reimbursements and to require additional benefits. Future levels
of funding of the Medicare program by the federal government cannot be predicted
with certainty.
The Company's ability to obtain and maintain favorable group benefit
agreements with employer groups affects the Company's profitability. The
agreements are generally renewable on an annual basis but are subject to
termination on 60 days prior notice. For the fiscal year ended December 31,
1996, the Company's ten largest HMO employer groups were, in the aggregate,
responsible for approximately 11% of the Company's total revenues. Although none
of such employer groups accounted for more than 3% of total revenues during that
period, the loss of one or more of the larger employer groups would, if not
replaced with similar membership, have a material adverse effect upon the
Company's business. The Company has generally been successful in retaining these
employer groups. However, there can be no assurance that the Company will be
able to renew its agreements with such employer groups in the future or that it
will not experience a decline in enrollment within its employer groups.
Additionally, revenues received under certain government contracts are subject
to audit and retroactive adjustment.
Provider Arrangements and Cost Management
HMO and Managed Indemnity Products. A significant distinction between the
Company's health care delivery system and that of many other managed care
providers is the fact that approximately 74% of the Company's Nevada HMO members
receive primary health care through the Company's own multi-specialty medical
group. The Company makes health care available through providers employed by the
multi-specialty medical group and an independently contracted network of
physicians, hospitals and other providers.
Under the Company's HMOs, the member selects a primary care physician who
provides or authorizes any non-emergency medical care given to that member.
These primary care physicians and some specialists are compensated to a limited
extent on the basis of how well they coordinate appropriate medical care. The
Company has a system of incentive risk arrangements and utilization management
with respect to its independently contracted primary care physicians. The
Company compensates its independently contracted primary care physicians and
specialists by using both capitation and modified fee-for-service payment
methods. Under both the capitation and modified fee-for-service methods, an
incentive risk arrangement is established for institutional services. Additional
amounts may be made available to certain capitated physicians if hospital costs
are less than anticipated for the Company's HMO members. For those primary care
physicians receiving payments on a modified fee-for-service basis, portions of
the payments otherwise due the physicians are withheld. The amounts withheld are
available for payment to the physicians if, at year-end, the expenditures for
both institutional and non-institutional medical services are within
predetermined, contractually agreed upon ranges. It is believed that this method
of incentive risk payment is advantageous to the physician, the Company and the
members because all share in the benefits of managing health care costs. The
Company has, however, negotiated capitation agreements with certain specialists
who do not participate in the incentive risk arrangements. The Company monitors
health care utilization, including evaluation of elective surgical procedures,
quality of care and financial stability of its capitated providers to facilitate
access to service and to ensure member satisfaction.
The Company also believes that it has negotiated favorable rates with its
contracted hospitals. The Company's contracts with its primary hospital
providers typically renew automatically with both parties granted the right to
terminate after a notice period varying from between three and twelve months.
Reimbursement arrangements with hospitals and other health care providers,
including pharmacies, are generally negotiated annually and are based on several
different payment methods, including per diems (where the reimbursement rate
varies and is based on a per day of service charge for specified types of care),
capitation or modified fee-for-service arrangements. To the extent possible,
when negotiating non-physician provider arrangements, the Company solicits
competitive bids.
5
The Company provides, or negotiates discounted contracts with hospitals for
the provision of, inpatient and outpatient hospital care, including room and
board, diagnostic tests and medical and surgical procedures. The Company
believes that it currently has a favorable contract with its primary southern
Nevada contracted hospital, Columbia Sunrise Hospital. Subject to certain
limitations, the contract provides, among other things, guaranteed contracted
per diem rate increases on an annual basis after December 31, 1997. Since a
majority of the Company's southern Nevada hospital days are at Columbia Sunrise
Hospital, this contract assists the Company in managing a significant portion of
its medical costs. The contract expires in the year 2012. The Company has
negotiated a capitation arrangement with Columbia Hospital, Inc. for hospital
services provided in Houston to members of the Company's Texas HMO.
The Company utilizes two reimbursement methods for health care providers
rendering services under the Company's indemnity plans. For services to members
utilizing a PPO plan, the Company reimburses participating physicians on a
modified fee-for-service basis which incorporates a limited fee schedule and
reimburses hospitals on a per diem or discounted fee-for-service basis. For
services rendered under a standard indemnity plan, pursuant to which a member
may select a non-plan provider, the Company reimburses non-contracted physicians
and hospitals at pre-established rates, less deductibles and co-insurance
amounts.
The Company also manages health care costs through its large case
management program, home health care agency, 24-hour urgent care centers and its
hospice which helps to minimize hospital admissions and lengths of stay. In
addition, the Company educates its members on how and when to use the services
of its plans and how to manage chronic disease conditions, and audits hospital
bills to identify inappropriate charges.
Risk Management
The Company maintains general and professional liability, property and
fidelity insurance coverage in amounts that it believes are adequate for its
operations. The Company's multi-specialty medical group maintains excess
malpractice insurance for the providers presently employed by the group. The
Company has, however, assumed the risk for the first $250,000 per malpractice
case, not to exceed $1.5 million in the aggregate per contract year up to its
limits of coverage. In addition, the Company requires all of its independently
contracted provider physician groups, individual practice physicians,
specialists, dentists, podiatrists and other health care providers (with the
exception of certain hospitals) to maintain professional liability coverage.
Certain of the hospitals with which the Company contracts are self-insured. The
Company also maintains stop-loss insurance that reimburses the Company between
50% and 90% of hospital charges for each individual member of its HMO or managed
indemnity plans whose hospital expenses exceed $75,000 during the contract year
and up to $2.0 million per member per lifetime. Workers' compensation claims are
reinsured between $350,000 and $60.0 million per occurrence. In the ordinary
course of its business, however, the Company is subject to claims that are not
insured, principally claims for punitive damages.
Information System
The Company has in place certain data systems which assist the Company in,
among other things, pricing its services, monitoring utilization and other cost
factors, providing bills on a timely basis, identifying accounts for collection
and handling various accounting and reporting functions. Its imaging and
workflow systems are used to process and track claims and coordinate customer
service. Where it is cost efficient, the Company's system is connected to large
provider groups, doctors' offices, payors and brokers to enable efficient
transfer of information and communication. The Company views its information
systems capability as critical to the performance of ongoing administrative
functions and integral to quality assurance and to the coordination of patient
care across care sites. The Company is continually modifying or improving its
information systems capabilities in an effort to improve operating efficiencies.
6
Quality Assurance and Improvement
The Company has developed programs to help ensure that the health care
services provided by its HMO and managed indemnity plans meet the professional
standards of care established by the medical community. The Company believes
that its emphasis on quality allows it to increase and retain its members. The
Company monitors and evaluates the availability and quality of the medical care
rendered by the providers in its HMO and insurance plans and periodically audits
selected diagnoses, problems and referrals to determine adherence to appropriate
standards of medical care. In addition, the Company has medical directors who,
supported by a professional medical staff, monitor the quality and
appropriateness of health care by analyzing a physician's utilization of
diagnostic tests, laboratory and radiology procedures, specialty referrals,
prescriptions and hospitals. Physicians and hospitals selected to provide
services to the Company's members are subject to the Company's quality assurance
programs including a formal credentialing process of all physicians.
The Company also has internal quality assurance and improvement review
committees that meet on a regular basis to review specialist referrals, monitor
the performance of physicians and review practice patterns, complaints and other
patient issues. Staff members regularly visit hospitals to review medical
records, meet with patients and review treatment programs and discharge plans
with attending physicians. In addition, the Company solicits information from
both existing and former members as to their satisfaction with the care
delivered. Complaints and grievances are responded to on both an informal and
formal basis, depending on the nature of the complaint.
With the increasing significance of managed care in the health care
industry, several independent organizations have been formed for the purpose of
responding to external demands for accountability over the managed care
industry. The organizations utilized by the Company are the National Committee
on Quality Assurance (the "NCQA") and the Joint Commission on Accreditation of
Healthcare Organizations ("JCAHO"). The NCQA performs site reviews of standards
established for quality assurance, credentialing, utilization management,
medical records, preventive services and member rights and responsibilities. The
JCAHO reviews rights, responsibilities and ethics, continuum of care, education
and communication, leadership, management of information and human resources and
network performance. In 1995, the Nevada HMO voluntarily applied for
accreditation from the NCQA with respect to its operations in southern Nevada,
which was denied. The Company has addressed most of the NCQA's findings for
Nevada and has recently gone through an NCQA site visit. The results are still
pending. The Company's Nevada multi-specialty clinic has received a full
three-year accreditation from the American Association for Ambulatory Health
Care -- the highest accreditation issued to ambulatory care facilities. The
clinic is the only multi-specialty site in Nevada to be awarded this
accreditation. Also, the Nevada HMO, along with the Company's managed indemnity
subsidiary, have received "excellent" ratings from the A.M. Best Company, an
independent insurance industry rating organization. The Company's workers'
compensation subsidiaries have received "very good" ratings from the A.M. Best
Company. There can be no assurance, however, that the Company will receive or
maintain NCQA or other accreditations in the future and there is no basis to
predict what effect, if any, the lack of NCQA or other accreditations will have
on the Nevada HMO's competitive position in southern Nevada.
7
Underwriting
HMO. The Company structures premium rates for its various health plans
primarily through community rating and community rating by class method. Under
the community rating method, all costs of basic benefit plans for the Company's
entire membership population are aggregated. These aggregated costs are
calculated on a "per member per month" basis and converted to premium rates for
coverage types, such as single or family coverage. The community rating by class
method is based on the same principles as community rating, except that
actuarial adjustments to premium rates are made for various employer groups
based on the average age and sex of their employees. All employees of an
employer group are charged the same premium rate if the same coverage is
selected.
In addition to those premium charges paid by the employers with whom the
Company's HMOs contract, members also pay co-payments at the time certain
services are provided. The Company believes that such co-payments encourage
appropriate utilization of health care services while allowing the Company to
offer competitive premium rates. The Company also believes that the capitation
method of provider compensation encourages physicians to provide only medically
necessary and appropriate care.
Managed Indemnity. Premium charges for the Company's managed indemnity
products are set in a manner similar to the community rating by class method
described above. This rate calculation utilizes age, sex and industry factors to
develop group-specific adjustments from a given base rate by plan. Actual health
claims experience is used to develop premium rates for larger insurance member
groups. This process includes the use of utilization experience, adjustments for
incurred but not reported claims, inflationary factors, credibility and specific
reinsurance pooling levels for large claims.
Workers' Compensation. Prior to insuring a particular risk, the Company
reviews, among other factors, the employer's prior loss experience and premium
payment history. Additionally, the Company determines whether the employer's
employment classifications are among the classifications that the Company has
elected to insure generally and if the amounts of the premiums for the
classifications are within the Company's guidelines. The Company reviews these
classifications periodically to evaluate whether they are profitable. A member
of the Company's loss control department may conduct an on-site safety
inspection before the Company insures the employer. The Company generally
initiates this inspection for enterprises with manufacturing or construction
classifications. The Company may also initiate inspections if the enterprise
previously has had a high loss ratio or frequent losses. If the on-site
inspection reveals hazards that can be corrected, and an agreement can be
reached with the employer that these hazards will be corrected in a time frame
established by the Company's underwriting department, the Company may issue a
policy subject to correction of those hazards. In the event the Company has
issued a policy where no previous inspection has been conducted, and
subsequently learns through an inspection the employer has hazards that must be
corrected, the Company will request that the employer correct the hazards within
a specified period of time. If these hazards are not corrected, the Company may
cancel the policy for non-compliance of the hazard correction. With regard to
new business, the agent or broker will usually submit the claims history on the
prospective account. In those situations where the claims history is not
supplied by the agent or broker, other sources (such as the prior insurer) are
used to obtain the appropriate claims history if possible.
In California, under open rating as it became effective for policyholders
in 1995, the Company has subdivided many of the standard classifications. These
subclassifications have been determined on the Company's perception of
differences in risk exposure. As a result, different rates have been filed for
each of these subclassifications. The use of these subclassifications requires
more detailed information than was required prior to open rating. The Company
ascertains characteristics of various employers through the use of
questionnaires and telephone inquiries by underwriters to determine the proper
subclassification. Subclassifications are subject to verification by loss
control and premium audits.
8
Competition
HMO and Managed Indemnity. Managed care companies and HMOs operate in a
highly competitive environment. The Company's major competition in Las Vegas is
from self-funded employer plans, PPO networks, other HMOs, such as Humana Care
Plus and Pacificare, Inc., and traditional indemnity carriers, such as Blue
Cross/Blue Shield. Many of the Company's competitors have substantially larger
total enrollments, have greater financial resources and offer a broader range of
products than the Company. Additional competitors with greater financial
resources than the Company may enter the Company's market in the future. The
Company believes that the most important competitive factors are the delivery of
reasonably priced, quality medical benefits to members and the adequacy and
availability of health care delivery services and facilities. The Company
depends on a large PPO network and flexible benefit plans to attract new
members. Competitive pressures are expected to limit the Company's ability to
increase premium rates and, to a lesser extent, to result in declining premium
rates. Accordingly, the profitability of the Company will, to a large extent,
depend on the Company's ability to manage the costs of providing health care
benefits to its members. The inability of the Company to manage these costs
would have an adverse impact on the Company's future results of operations by
reducing margins. In addition, competitive pressures may also result in reduced
membership levels. Any such reductions could materially affect the Company's
results of operations.
Workers' Compensation. The Company's workers' compensation business is
concentrated in California, a state where the workers' compensation insurance
industry is extremely competitive. Based upon data provided by the Workers'
Compensation Insurance Rating Bureau ("WCIRB"), for the year ended December 31,
1995, which is the latest data available, there were approximately 225 insurance
companies writing workers' compensation insurance in California. Many of the
Company's competitors have been in business longer, have a larger volume of
business, offer a more diversified line of insurance coverage, have greater
financial resources and have greater distribution capability than the Company.
The largest writer of workers' compensation insurance in California is the State
Compensation Insurance Fund. Prior to 1995, the Company concentrated on insuring
workers' compensation accounts in the small- to medium-size range. Under the
current open rating environment, the Company is actively pursuing accounts of
all sizes.
In all states in which the Company is currently writing business,
competition for workers' compensation insurance is primarily driven by price and
secondarily by services provided to insureds and agents. In states other than
California, commissions are normally not a dominant competitive factor. In those
other states, the National Council on Compensation Insurance ("NCCI") is usually
the designated rating organization. Like the WCIRB in California, the NCCI
accumulates statistical information and recommends pure loss costs to the
state's Department of Insurance. As in California under the open rating
environment, the Company then adds loss cost multipliers or expense loads to
derive premium rates. Rating plans in those states are more "standardized" and
are usually based on plans developed by the NCCI. Unlike California, where the
Company has developed subclasses, the Company will use standard classes in the
other states.
Losses and Loss Adjustment Expenses
Often, in workers' compensation insurance, several years may elapse between
the occurrence of a loss and the final settlement of the loss. To recognize
liabilities for unpaid losses, the Company establishes reserves, which are
balance sheet liabilities representing estimates of future amounts needed to pay
claims and related expenses for insured events, including reserves for events
that have occurred but have not yet been reported to the Company ("IBNR").
9
When a claim is reported, the Company's claims personnel initially
establish reserves on a case-by-case basis for the estimated amount of the
ultimate payment. These estimates reflect the judgment of the claims personnel
based on their experience and knowledge of the nature and value of the specific
type of claim and the available facts at the time of reporting as to severity of
injury and initial medical prognosis. Included in these reserves are estimates
of the expenses of settling claims, including legal and other fees, and the
general expenses of administering the claims adjustment process. Claims
personnel adjust the amount of the case reserves as the claim develops and as
the facts warrant.
IBNR reserves are established for unreported claims and loss development
relating to current and prior accident years. In the event that a claim that
occurred during a prior accident year was not reported until the current
accident year, the case reserve for such claim typically will be established out
of previously established IBNR reserves for that prior accident year.
The Company reviews the adequacy of its reserves on a monthly basis and
considers 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 loss adjustment expenses
("LAE") to change. Reserves are reviewed with the Company's independent actuary
at least annually. The actuarial projections include a range of estimates
reflecting the uncertainty of projections. Management evaluates the reserves in
the aggregate, based upon the actuarial indications and makes adjustments where
appropriate. The consolidated financial statements of the Company provide for
reserves based on the anticipated ultimate cost of losses.
Once an employer is insured by the Company, the Company's loss control
department may assist the insured in developing and maintaining safety programs
and procedures to minimize on-the-job injuries and industrial health hazards.
The safety programs and procedures vary from insured to insured. The Company's
loss control department may recommend to the employer that a safety committee
consisting of members of the employer's management staff and its general labor
force be established. The Company's loss control department may then assist the
committee members in isolating safety hazards, advising the committee on how to
correct the hazards and assisting the employer in establishing procedures to
enforce the corrections. The Company's loss control department may also revisit
the employer to determine whether the recommended corrections and procedures
have been implemented. Depending upon the size, classifications, and loss
experience of the employer, the Company's loss control department will
periodically inspect the employer's places of business and may recommend changes
that could prevent industrial accidents. In addition, severe or recurring
injuries may also warrant on-site inspections. In certain instances, members of
the Company's loss control department may conduct special educational training
sessions for insured employees to assist in the prevention of on-the-job
injuries. For example, employers engaged in manufacturing may be offered a
training session on how to prevent back injuries or employers engaged in
contracting may be offered a training session on general first aid and
prevention of injuries that may result from specific work exposures.
Government Regulation and Recent Legislation
HMOs and Managed Indemnity. Federal and state governments have enacted
statutes extensively regulating the activities of HMOs. In addition, growing
government concerns over increasing health care costs could result in new or
additional state or federal legislation that could affect health care providers,
including HMOs, PPOs and other health insurers. Among the areas regulated by
federal and state law are the scope of benefits available to members, premium
structure, procedures for review of quality assurance, enrollment requirements,
the relationship between an HMO and its health care providers, licensing and
financial condition.
10
The Company must file periodic reports with, and is subject to periodic
review and audit by, federal and state licensing authorities. The Company has
HMO licenses in Nevada and Texas and is subject to regulation by the Nevada
Division of Insurance, the Nevada Division of Health and the Texas Department of
Insurance. The Company's health insurance subsidiary is domiciled and
incorporated in California and is licensed in 26 states, with current operations
in Nevada, Arizona, Colorado, Texas, California, New Mexico, Missouri and
Mississippi. It is subject to licensing by and other regulations of the
California Department of Insurance as well as the insurance departments of other
states in which it operates or holds licenses. The Company's premium rate
increases are subject to various state insurance department approvals. The
Company's HMO and insurance subsidiaries are also required by state regulatory
agencies to maintain certain deposits and must also meet certain net worth and
reserve requirements. The Company also has certain other deposit requirements.
The Company has restricted assets on deposit in various states ranging from
$20,000 to $2.2 million and totalling $13.6 million at December 31, 1996. The
Company's HMO and insurance subsidiaries meet requirements to maintain minimum
stockholder's equity ranging from $200,000 to $5.2 million. The Company's Nevada
HMO and health insurance subsidiaries currently maintain home offices and a
regional home office, respectively, in Las Vegas and, accordingly, are eligible
for certain premium tax credits in Nevada.
The Company's HMO subsidiaries are also restricted by state law as to the
amount of dividends that can be declared and paid. Moreover, insurance companies
and HMOs domiciled in Texas, Nevada and California generally may not pay
extraordinary dividends without providing the state insurance commissioner with
30 days prior notice, during which period the commissioner may disapprove the
payment. An "extraordinary dividend" is generally defined as a dividend whose
fair market value together with that of other dividends or distributions made
within the preceding 12 months exceeds the lesser of (i) ten percent of the
insurer's surplus as of the preceding December 31 or (ii) the net gain from
operations of such insurer, not including realized capital gains, for the
12-month period ending on the preceding December 31. The Company is not in a
position to assess the likelihood of obtaining future approval for the payment
of "extraordinary dividends" or dividends other than those specifically allowed
by law in each of its subsidiaries' states of domicile. No prediction can be
made as to whether any legislative proposals relating to dividend rules in the
domiciliary states of the Company's subsidiaries will be made or adopted in the
future, whether the insurance departments of such states will impose either
additional restrictions in the future or a prohibition on the ability of the
Company's regulated subsidiaries to declare and pay dividends or as to the
effect of any such proposals or restrictions on the Company's regulated
subsidiaries.
The Company is subject to the Federal HMO Act and the regulations
promulgated thereunder. Of the Company's three subsidiary HMOs, only MedOne
Health Plan, acquired at the end of 1996, is not federally- qualified under this
Act. In order to obtain federal qualification, an HMO must, among other things,
provide its members certain services on a fixed, prepaid fee basis and set its
premium rates in accordance with certain rating principles established by
federal law and regulation. The HMO must also have quality assurance programs in
place with respect to its health care providers. Furthermore, an HMO may not
refuse to enroll an employee, in most circumstances, because of such person's
health, and may not expel or refuse to re-enroll individual members because of
their health or their need for health services.
Under the "corporate practice of medicine" doctrine, in most states,
business organizations, other than those authorized to do so, are prohibited
from providing, or holding themselves out as providers of, medical care. Some
states, including Nevada, exempt HMOs from this doctrine. The laws relating to
this doctrine are subject to numerous conflicting interpretations. Although the
Company seeks to structure its operations to comply with corporate practice of
medicine laws in all states in which it operates, there can be no assurance
that, given the varying and uncertain interpretations of those laws, the Company
would be found to be in compliance with those laws in all states. A
determination that the Company is not in compliance with applicable corporate
practice of medicine laws in any state in which it operates could have a
material adverse effect on the Company if it were unable to restructure its
operations to comply with the laws of that state.
11
Medicare and Medicaid antifraud and abuse provisions are codified at 42
U.S.C. Sections 1320a-7(b) (the "Anti-kickback Statute") and 1395nn (the "Stark
Amendments"). Many states have similar anti-kickback and anti-referral laws.
These statutes prohibit certain business practices and relationships involving
the referral of patients for the provision of health care items or services
under certain circumstances. Sanctions for violations of the Anti-kickback
Statute and the Stark Amendments include criminal penalties and civil sanctions,
including fines and possible exclusion from the Medicare and Medicaid programs.
Similar penalties are provided for violation of state anti-kickback and
anti-referral laws. The Department of Health and Human Services ("HHS") has
issued regulations establishing "safe harbors" with respect to the Anti-
kickback Statute. The Office of the Inspector General recently proposed new
rules to clarify those safe harbors. HHS has also proposed to establish certain
safe harbors under the Stark Amendments. The Company believes that its business
arrangements and operations are in compliance with the Anti-kickback Statute and
the Stark Amendments and the exceptions set forth therein, regardless of the
availability of regulatory safe harbor protection with respect to those
statutes. There can, however, be no assurance that (i) government officials
charged with responsibility for enforcing the prohibitions of the Anti-kickback
Statute and the Stark Amendments will not assert that the Company or certain
transactions in which it is involved are in violation of those statutes and (ii)
such statutes will ultimately be interpreted by the courts in a manner
consistent with the Company's interpretation.
As a result of the continued escalation of health care costs and the
inability of many individuals to obtain health care insurance, numerous
proposals relating to health care reform have been or may be introduced in the
United States Congress and state legislatures. Any proposals affecting
underwriting practices, limiting rate increases, requiring new or additional
benefits or affecting contracting arrangements (including proposals to require
HMOs and PPOs to accept any health care providers willing to abide by an HMO's
or PPO's contract terms) may have a material adverse effect on the Company's
business.
For example, recent news reports indicate that President Clinton may submit
a budget proposal to Congress that will reduce Medicare spending by $100 billion
and impose certain limits on Medicaid spending. Although neither the present
administration's health care reform proposals nor alternative health care reform
proposals introduced by certain members of Congress were previously adopted, the
Health Insurance Portability and Accountability Act of 1996 (the "Accountability
Act") was passed by Congress and signed into law by President Clinton on August
21, 1996 and will generally take effect beginning July 1, 1997. While the
Accountability Act contains provisions regarding health insurance or health
plans, such as portability and limitations on pre-existing condition exclusions,
guaranteed availability and renewability, it also contains several anti-fraud
measures that significantly change health care fraud and abuse provisions. Some
of the provisions include (i) creation of an anti-fraud and abuse trust fund and
coordination of fraud and abuse efforts by federal, state and local authorities,
(ii) extension of the criminal anti-kickback statues to all federal health
programs, (iii) expansion of and increase in the amount of civil monetary
penalties and establishment of a knowledge standard for individuals or entities
potentially subject to civil monetary penalties, and (iv) revisions to current
sanctions for fraud and abuse, including mandatory and permissive exclusion from
participation in the Medicare or Medicaid programs. The Company does not believe
that the Accountability Act should have a material adverse effect on the
Company's operations, but is unable to predict the ultimate impact of any
federal or state restructuring of the health care financing and delivery system,
which ultimately could have a material adverse impact on the operations,
financial condition and prospects of the Company.
Workers' Compensation. The Company is subject to extensive governmental
regulation and supervision in each state in which it conducts workers'
compensation business. The primary purpose of such regulation and supervision is
to provide safeguards for policyholders and injured workers rather than protect
the interests of shareholders. The extent and form of the regulation may vary,
but generally has its source in statutes that establish regulatory agencies and
delegate to the regulatory agencies broad regulatory, supervisory and
administrative authority. Typically, state regulations extend to such matters as
licensing companies; restricting the types or quality of investments; requiring
triennial financial examinations
12
and market conduct surveys of insurance companies; licensing agents; regulating
aspects of a company's relationship with its agents; restricting use of some
underwriting criteria; regulating rates, forms and advertising; limiting the
grounds for cancellation or nonrenewal of policies, solicitation and replacement
practices; and specifying what might constitute unfair practices. Moreover, the
payment of dividends and the making of other distributions to the Company by its
workers' compensation insurance company subsidiaries are contingent upon the
earnings of those subsidiaries and are subject to various business
considerations, applicable state corporate laws and regulations, the terms of
agreements to which they may become a party and government regulations, which
restrict in certain circumstances the payment of dividends and distributions and
the transfer of assets to the Company.
In the normal course of business, the Company and the various state
agencies that regulate the activities of the Company may disagree on
interpretations of laws and regulations, policy wording and disclosures or other
related issues. These disagreements, if left unresolved, could result in
administrative hearings and/or litigation. The Company attempts to resolve all
issues with the regulatory agencies, but is willing to litigate issues where it
believes it has a strong position. The ultimate outcome of these disagreements
could result in sanctions and/or penalties and fines assessed against the
Company. Currently, there are no litigation matters pending with any department
of insurance.
Typically, states mandate participation in insurance guaranty associations,
which assess solvent insurance companies in order to fund claims of
policyholders of insolvent insurance companies. Under this arrangement, insurers
can be assessed up to 1% (or 2% in certain states) of premiums written for
workers' compensation insurance in that state each year to pay losses and LAE on
covered claims of insolvent insurers. In California and certain other states,
insurance companies are allowed to recoup such assessments from policyholders
while several states allow an offset against premium taxes. Potential assessment
expenses, net of recoupment, if any, for insolvencies are not accrued until
after an insolvency has occurred since the likelihood and the amount of the
assessment expense cannot be reasonably determined or estimated. In California,
there have been no new assessments for insolvent workers' compensation insurance
companies since 1990.
California's Insurance Holding Company Act regulates the payment of
shareholder dividends by insurance companies. To date, the workers' compensation
insurance subsidiaries have not paid dividends to the Company.
General. Besides state insurance laws, the Company is subject to general
business and corporation laws, federal and state securities laws, consumer
protection laws, fair credit reporting acts and other laws regulating the
conduct and operation of its subsidiaries.
Employees
The Company had approximately 2,600 employees on December 31, 1996. None of
these employees are covered by a collective bargaining agreement. The Company
believes that its relations with its employees are good.
13
ITEM 2. PROPERTIES
The Company owns several administrative facilities in southern Nevada
totalling approximately 221,000 square feet. Such facilities include an
approximate 134,000 square foot six-story home office building and an
approximate 43,000 square foot two-story corporate administrative headquarters.
These buildings are subject to liens securing a $7.8 million loan balance from
Bank of America. The Company also owns several clinical facilities in the
southern Nevada area totalling approximately 319,000 square feet and consisting
primarily of six medical clinics and two surgery centers. Certain clinical space
is subject to a $3.2 million mortgage in favor of GE Capital Asset Management
Corporation. The Company leases additional office and clinical space in Nevada
totalling approximately 137,000 and 59,000 square feet, respectively. The
Company owns real estate and a building in Park City, Utah purchased in 1996 to
provide entertainment and a meeting environment for significant current and
prospective clients, brokers and others who assist in the Company's marketing
efforts. In connection with its workers' compensation insurance subsidiary, the
Company leases approximately 141,000 square feet of office space in California.
The Company also leases approximately 42,000 square feet of office space in
various states as needed for other regional operations, including the Texas HMO.
The Company has begun construction of an approximately 59,000 square foot
medical facility in Las Vegas with an estimated total cost of $7.3 million.
Completion is expected in the fourth quarter of 1997. The Company believes that
current and planned clinical space will be adequate for its present needs.
Additional clinical space may be required, however, if membership continues to
expand in southern Nevada. The Company has also begun construction of an
additional administrative building of approximately 180,000 square feet. Costs
are expected to be approximately $35.0 million, and completion is scheduled for
the fourth quarter of 1997. The land was purchased for approximately $2.0
million in December 1995.
ITEM 3. LEGAL PROCEEDINGS
On March 18, 1997, the Company announced it had terminated its merger
agreement with Physician Corporation of America ("PCA"). The original agreement
had been entered into in November 1996. On March 18, 1997, prior to termination
of the merger agreement, PCA filed a lawsuit against the Company in the United
States District Court for the Southern District of Florida (the "District
Court"), seeking, among other things, specific performance of the merger
agreement and monetary damages. While the Company believes the PCA lawsuit is
without merit, there can be no assurance as to the outcome of the PCA lawsuit.
The Company has filed a motion in the District Court seeking a dismissal of the
PCA lawsuit for lack of diversity jurisdiction. The Company has also initiated a
lawsuit in the Court of Chancery of the State of Delaware seeking a declaratory
judgment as well as other remedies. The Company intends to vigorously pursue all
remedies available to it, however, there can be no assurance that the Company
will prevail in such litigation or that PCA will have sufficient funds to pay
any damages that the Company may be awarded.
The Company is subject to various claims and other litigation in the
ordinary course of business. Such litigation includes claims of medical
malpractice, claims for coverage or payment for medical services rendered to HMO
members and claims by providers for payment for medical services rendered to HMO
members. Also included in such litigation are claims for workers' compensation
and claims by providers for payment for medical services rendered to injured
workers. In the opinion of the Company's management, the ultimate resolution of
pending legal proceedings should not have a material adverse effect on the
Company's financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
14
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
Market Information
The Company's common stock, par value $.005 per share (the "Common Stock"),
has been listed on the New York Stock Exchange under the symbol SIE since April
26, 1994 and, prior to that, was listed on the American Stock Exchange since the
Company's initial public offering on April 11, 1985. The following table sets
forth the high and low sales prices for the Common Stock on the respective
exchanges for each quarter of 1996 and 1995.
Period High Low
1996
First Quarter........................................ $36 $29 7/8
Second Quarter....................................... 35 7/8 29
Third Quarter........................................ 34 7/8 25 1/4
Fourth Quarter....................................... 34 3/8 22 3/8
1995
First Quarter........................................ $32 7/8 $27 3/8
Second Quarter....................................... 33 5/8 22 1/8
Third Quarter........................................ 29 23
Fourth Quarter....................................... 33 1/8 24 1/8
On March 14, 1997, the closing sale price of the common stock was $26 1/2 per
share.
Holders
The number of record holders of Common Stock at March 14, 1997 was 318.
Based upon information available to it, the Company believes there are several
thousand beneficial holders of the Common Stock.
Dividends
No cash dividends have been paid on the Common Stock since the Company's
inception. The Company currently intends to retain its earnings for use in its
business and does not anticipate paying any cash dividends in the foreseeable
future. As a holding company, the Company's ability to declare and to pay
dividends is dependent upon cash distributions from its operating subsidiaries.
The ability of the Company's HMO and insurance subsidiaries to declare and to
pay dividends is limited by state regulations applicable to the maintenance of
minimum deposits, reserves and net worth. (See Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources.) The declaration of any future dividends will be at the
discretion of the Company's Board of Directors and will depend on, among other
things, future earnings, debt covenants, operations, capital requirements and
the financial condition of the Company and upon general business conditions.
15
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data of Sierra Health
Services, Inc., and subsidiaries (the "Company"), for each of the fiscal years
in the five-year period ended December 31, 1996 should be read in conjunction
with the Consolidated Financial Statements and the related Notes thereto,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other information which appears elsewhere in this Annual Report
on Form 10-K. The selected consolidated financial data below has been derived
from the audited Consolidated Financial Statements of the Company.
Years Ended December 31,
1996 1995 1994 1993 1992
(Amounts in thousands, except per share data)
Statement of Operations Data (1):
OPERATING REVENUES:
Medical Premiums............................................. $386,968 $319,475 $269,382 $240,691 $217,624
Specialty Product Revenue.................................... 133,324 102,807 101,287 113,714 107,229
Professional Fees............................................ 28,836 19,417 12,331 11,254 10,206
Investment and Other Revenue................................. 26,283 25,310 19,081 17,771 15,397
Total...................................................... 575,411 467,009 402,081 383,430 350,456
OPERATING EXPENSES:
Medical Expenses............................................. 315,915 245,135 200,229 178,526 166,495
Specialty Product Expenses................................... 130,758 102,859 96,600 118,868 156,042
General, Administrative and Marketing Expenses............... 72,237 63,562 53,671 50,715 44,176
Acquisition, Restructuring and Other Expenses (2) ........... 12,064 11,614
Total...................................................... 530,974 423,170 350,500 348,109 366,713
OPERATING INCOME (LOSS) ........................................ 44,437 43,839 51,581 35,321 (16,257)
OTHER INCOME (EXPENSE):
Minority Interests .......................................... 2,065 2,471 (113) (179) (249)
Interest Expense and Other, Net.............................. (4,888) (6,208) (6,288) (4,258) (4,641)
Litigation Settlement........................................ (784)
Total...................................................... (2,823) (3,737) (6,401) (4,437) (5,674)
Income (Loss) from Continuing Operations
Before Income Taxes ....................................... 41,614 40,102 45,180 30,884 (21,931)
Provision for Income Taxes...................................... 10,471 12,198 8,236 8,435 7,045
Income (Loss) from Continuing Operations........................ 31,143 27,904 36,944 22,449 (28,976)
Loss from Discontinued Operations .............................. (6,600) (2,501) (404)
Extraordinary Gain ............................................. 457
Cumulative Effect of Adopting FAS 109........................... 5,250
NET INCOME (LOSS)............................................... $ 31,143 $ 21,304 $ 34,443 $ 27,295 $(28,519)
EARNINGS PER COMMON SHARE (3)
Income (Loss) from Continuing Operations
Per Share ................................................. $1.76 $1.60 $2.36 $1.50 $ (1.98)
Loss Per Share from Discontinued Operations ................. (.38) (.16) (.02)
Extraordinary Gain Per Share ................................ .03
Cumulative Effect of Adopting FAS 109. ...................... .35
Net Income (Loss) Per Share ................................. $1.76 $1.22 $2.20 $1.83 $ (1.95)
Weighted Average Number of Common
Shares Outstanding ........................................ 17,726 17,414 15,678 14,939 14,601
16
Years Ended December 31,
1996 1995 1994 1993 1992
(Amounts in thousands)
Balance Sheet Data:
Working Capital ............................................. $ 76,530 $ 18,157 $ 71,337 $ 21,323 $ 10,578
Total Assets................................................. 629,462 575,146 535,487 445,510 373,848
Long-term Debt (Net of Current Maturities)................... 66,189 71,257 75,209 72,802 64,461
Cash Dividends Per Common Share.............................. NONE NONE NONE NONE NONE
Stockholders' Equity......................................... 234,482 207,715 168,157 84,708 54,380
(1) The Company's consolidated financial statements have been restated to
reflect the results of acquisitions accounted for in accordance with
pooling of interests method of accounting. See Note 1 of Notes to the
Consolidated Financial Statements.
(2) In connection with certain acquisitions and restructurings, the Company
recorded certain non-recurring incremental costs. See Note 13 of Notes to
the Consolidated Financial Statements.
(3) Adjusted to account for a two-for-one stock split of the Company's common
stock in 1992.
ITEM 7. 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 assessment and understanding of the Company's
consolidated financial condition and results of operations. The discussion
should be read in conjunction with the Condensed Consolidated Financial
Statements and Related Notes thereto. Any forward-looking information contained
in this Management's Discussion and Analysis of Financial Condition and Results
of Operations and any other sections of this 1996 Annual Report on Form 10-K
should be considered in connection with certain cautionary statements contained
in the Company's Current Report on Form 8-K filing dated March 28, 1997. Such
cautionary statements are made pursuant to the "safe harbor" provisions of the
Private Securities Litigation Reform Act of 1995 and identify important risk
factors that could cause the Company's actual results to differ from those
expressed in any projected, estimated or forward-looking statements relating to
the Company.
Acquisitions
Effective December 31, 1996, the Company purchased Prime for approximately
$32.2 million in cash. At December 31, 1996, Prime operated MedOne Health Plan,
Inc., a 12,800 member HMO, and also served 215,000 people through preferred
provider organizations, workers' compensation programs, and administrative
services products for self-insured employers and union welfare funds, primarily
in the state of Nevada. The acquisition of Prime has been accounted for as a
purchase and, therefore, none of Prime's prior operations have been included in
the information contained in this discussion and analysis; however, all of the
acquired assets and liabilities have been reflected in the Company's ending
consolidated balance sheet, along with the associated goodwill.
In November 1996, the Company acquired the remaining ownership interests of
HMO Texas for $5.0 million. The Company had previously held a 50 percent
interest in the Houston-based health plan which had approximately 12,700 members
at the end of 1996.
On October 31, 1995, the Company acquired CII Financial, Inc., a workers'
compensation insurance holding company, for approximately $76.3 million of
common stock, in a transaction accounted for as a pooling of interests. The
information contained in this discussion and analysis has been restated to
include the results of CII for all periods presented.
17
Overview
The Company derives revenues from its health maintenance organizations,
managed indemnity and workers' compensation insurance subsidiaries. To a lesser
extent, the Company also derives additional specialty product revenues from
non-HMO and insurance products (consisting of fees for workers' compensation
administration, utilization management services and ancillary products),
professional fees (consisting primarily of fees for providing health care
services to non-members and co-payment fees received from members), and
investment and other revenue. Medical premium revenues accounted for
approximately 67.3%, 68.4%, and 67.0% of the Company's total revenues for 1996,
1995 and 1994, respectively. Continued medical premium revenue growth is
principally dependent upon continued enrollment in the Company's products and
upon competitive and regulatory factors which are expected to limit the
Company's ability to implement annual premium rate increases.
The Company's principal expenses consist of medical expenses, specialty
product expenses, and general, administrative and marketing expenses. Medical
expenses represent the aggregate expenses of operating the Company's
multi-specialty medical group and other provider subsidiaries as well as
capitation fees and other fee-for-service payments paid to independently
contracted physicians, hospitals and other health care providers. As a provider
of managed care services, the Company seeks to manage medical expenses by
employing or contracting with physicians, hospitals and other health care
providers at negotiated price levels, by adopting quality assurance programs, by
monitoring and managing utilization of physicians and hospital services and by
providing incentives to use cost-effective providers. Specialty product expenses
primarily consist of losses and loss adjustment expenses, and underwriting
expenses associated with the Company's workers' compensation insurance
subsidiaries. General, administrative and marketing expenses generally represent
operational costs other than those associated with the delivery of health care
services and specialty product services.
Acquisition, restructuring and other expenses represent the non-recurring
incremental costs the Company has incurred in connection with various mergers,
acquisitions and planned dispositions.
18
Results of Operations
The following table sets forth selected operating data as a percentage of
revenues for the periods indicated:
Years Ended December 31,
1996 1995 1994
OPERATING REVENUES:
Medical Premiums........................................ 67.3% 68.4% 67.0%
Specialty Product Revenue............................... 23.2 22.0 25.2
Professional Fees....................................... 5.0 4.2 3.1
Investment and Other Revenue............................ 4.5 5.4 4.7
Total................................................ 100.0 100.0 100.0
OPERATING EXPENSES:
Medical Expense......................................... 54.9 52.5 49.8
Specialty Product Expense............................... 22.7 22.0 24.0
General, Administrative and Marketing Expenses.......... 12.6 13.6 13.4
Acquisition, Restructuring and Other Expenses .......... 2.1 2.5
Total................................................ 92.3 90.6 87.2
OPERATING INCOME ............................................ 7.7 9.4 12.8
OTHER INCOME (EXPENSE):
Minority Interests ..................................... 0.4 0.5
Interest Expense and Other, Net......................... (0.9) (1.3) (1.6)
Total................................................ (0.5) (0.8) (1.6)
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES .................................... 7.2 8.6 11.2
PROVISION FOR INCOME TAXES................................... 1.8 2.6 2.0
INCOME FROM CONTINUING OPERATIONS ........................... 5.4 6.0 9.2
NET OPERATING LOSS ON DISCONTINUED
OPERATIONS .............................................. (.4) (.6)
NET LOSS ON DISPOSAL OF
DISCONTINUED OPERATIONS .................................. (1.0)
NET INCOME................................................... 5.4% 4.6% 8.6%
19
1996 Compared to 1995
Revenues. The Company's total operating revenues for 1996 increased 23.2%
to $575.4 million from $467.0 million for 1995. The increase was primarily due
to medical premium revenue increases of approximately $67.5 million, or 21.1%,
from the Company's HMO and managed indemnity insurance subsidiaries. Such
premium growth resulted principally from a 19.6% increase in member months. The
Company experienced an overall rate increase for its Medicare members due to an
approximate 2.9% increase in its capitation rate established by HCFA.
Additionally, the Company realized minimal rate changes for the HMO subsidiary's
commercial groups and managed indemnity insurance subsidiary. The Company's
specialty product revenue increased $30.5 million, or 29.7%, to $133.3 million
in 1996 from $102.8 million in 1995. Such increases were primarily from workers'
compensation premiums in California. Professional fees increased $9.4 million,
or 48.5%, over 1995 to $28.8 million. This increase is due primarily to the
acquisition of a medical facility in the fourth quarter of 1995 as well as
expanded services at the Company's existing medical facilities. Investment and
other revenue increased $1.0 million, or 3.8%, over the prior year due to
changes in the investment balances and market yield fluctuations.
Medical and Specialty Product Expenses. Total medical expenses increased by
$70.8 million in 1996 compared to 1995. This 28.9% increase resulted from the
consolidated member month growth discussed above, as well as the clinical
expansions and increases associated with professional fee growth. These factors,
as well as an increase in Medicare members as a percentage of total members,
increased the Company's medical loss ratio to 76.0% for the twelve months ended
December 31, 1996, from 72.3% for the comparable twelve months in 1995. The cost
of providing medical care to Medicare members generally requires a greater
percentage of the premium revenue received. Specialty product expenses increased
$27.9 million, or 27.1%, over 1995. This increase is due primarily to the
increase in workers' compensation premiums noted above, offset in part by the
Company's ability to overlay managed care techniques on the management and
payment of certain workers' compensation claims. In addition, specialty product
expenses for 1996 and 1995 were impacted by the loss development on prior
accident years. During the year, the Company had net favorable loss development
on prior accident years of $15.3 million, compared to net favorable loss
development of $20.1 million for the comparable prior year period. The majority
of the favorable loss development occurred on the 1992 through 1994 accident
years. The favorable development on the 1992 accident year appears to be
primarily due to the Company's aggressive actions to resolve claims. The
favorable development on the 1993 and 1994 accident years appears to have been
aided by the workers' compensation reforms that were enacted in July 1993 to
combat the abuses in the California workers' compensation system. There can be
no assurances that favorable development, or the magnitude of the development,
will continue in the future. See Note 6 of Notes to Consolidated Financial
Statements.
General, Administrative and Marketing Expenses. General, administrative and
marketing ("G&A") costs increased $8.7 million, or 13.6%, for the twelve months
ended December 31, 1996 compared to the twelve months ended December 31, 1995.
As a percentage of revenues, however, G&A costs for the twelve months ended
December 31, 1996 decreased to 12.6% from 13.6% during the comparable period in
1995. Of the $8.7 million increase in G&A, $3.3 million is in compensation costs
primarily resulting from additional employees supporting expanded services, $3.8
million is from percent of premium costs such as broker commissions and premium
taxes, and the remaining $1.6 million is made up of various changes which
individually are insignificant.
Acquisition, Restructuring and Other Expenses. During 1995, as part of the
Company's clinical expansion and growth efforts, the Company acquired a medical
facility in Mohave County, Arizona, across the border from Laughlin, Nevada.
This medical facility included a small 12 bed hospital. During 1996 the Company
implemented a plan to exit the hospital business and has actively pursued buyers
for this business. As a result of this plan, the Company took a charge of $3.8
million ($2.8 million after tax) in the fourth quarter of 1996, primarily to
recognize the estimated costs to dispose of the hospital.
20
As a result of higher than expected claim and administrative costs relative
to premium rates that can be obtained in certain regional insurance operations
and the Company's inability to negotiate adequate provider contracts due to its
limited presence in some of these markets, the Company adopted a plan to
restructure certain insurance operations during the third quarter of 1996 and
recorded a charge of $8.3 million. The plan included the sale or closure of
certain regional operations in California, Arizona, and Colorado. The plan will
allow the Company to focus on more favorable operating markets and improve
operating efficiencies. The Company believes that this restructuring, over time,
will result in improved cash flow and operating cost savings in excess of the
amount of the charge.
As a result of these restructurings, the Company recorded expenses of $12.1
million. These costs included cancellation of certain contractual obligations of
$6.0 million, lease termination costs of $1.5 million, and $4.6 million of other
costs including the estimated costs to dispose of the hospital. As of December
31, 1996, approximately $4.1 million of these costs had been paid or otherwise
charged against the accrual and the Company estimates that most of the remaining
cash expenditures will be paid over the next twelve months.
Income Taxes. The Company's effective tax rate for the year ended December
31, 1996 was 25.2%, compared to 30.4% in 1995, or 25.4% after taking into
account the non-deductible merger costs incurred in 1995. The difference between
the Company's effective tax rate and the current federal tax rate is due
primarily to a $2.7 million tax benefit recorded as a result of a reduction of
the deferred tax valuation allowance and the Company's significant portfolio of
tax preferred investments. See Note 8 of Notes to Consolidated Financial
Statements.
Net Income. Net income for 1996 increased $9.8 million, or 46.2%, over
1995. This increase was impacted in part by several non-recurring items
including the restructurings in 1996 and discontinued operations and merger
costs in 1995. Excluding non-recurring items and the related tax effects, income
from ongoing operations for 1996 increased $2.6 million, or 6.9%.
1995 Compared to 1994
Revenues. The Company's total operating revenues for 1995 increased 16.1%
to $467.0 million from $402.1 million for 1994. The increase was primarily due
to medical premium revenue increases of approximately $50.1 million, or 18.6%
from the Company's HMO and managed indemnity insurance subsidiaries. Such
premium growth resulted principally from a 12.5% increase in member months. The
Company experienced an overall rate increase for its Medicare members due to an
approximate 7.5% increase in its capitation rate established by HCFA.
Additionally, the Company realized minimal rate changes for the HMO subsidiary's
commercial groups and managed indemnity insurance subsidiary. The Company's
specialty product revenue increased slightly to $102.8 million in 1995 from
$101.3 million in 1994. Specialty product revenue increased by $1.7 million in
Nevada and $2.0 million in all other states excluding California. Such increases
were offset by a $2.2 million decrease in the amount of specialty product
revenue earned in California. The decrease in California specialty product
revenues is primarily due to the abolishment of minimum premium rates in the
California workers' compensation market and the commencement of open rating
effective January 1, 1995, as well as a 16% rate decrease which had occurred
October 1, 1994. Professional fees increased by $7.1 million, or 57.5% over 1994
due principally to the opening of three new medical clinics (one in the latter
part of 1994 and two in 1995), a new surgery center, and the acquisition of a
medical facility. Investment and other revenue increased $6.2 million, or 32.6%,
primarily due to increased investment balances from the Company's common stock
offering completed in October 1994.
21
Medical and Specialty Product Expense. Total medical expenses increased by
approximately $44.9 million in 1995 compared to 1994. This 22.4% increase
resulted from the consolidated member month growth discussed above, as well as
the clinical expansions and increases associated with professional fee growth.
These factors, as well as an increase in Medicare members as a percentage of
total members, increased the Company's medical loss ratio to 72.3% for the
twelve months ended December 31, 1995, from 71.1% for the comparable twelve
months in 1994. The cost of providing medical care to Medicare members generally
requires a greater percentage of the premium revenue received. Specialty product
expenses increased by 6.5% over 1994. This increase is primarily the result of a
higher loss ratio in 1995 due to the decrease in premium rates discussed above,
offset in part by favorable development during 1995 in reserves for prior
accident years. During the year, the Company had net favorable loss development
on prior accident years of $20.1 million, compared to net favorable loss
development of $14.0 million for the comparable prior year period. The majority
of the favorable loss development occurred on the 1992 and 1993 accident years.
The favorable development on the 1992 accident year appears to be primarily due
to the Company's aggressive actions to resolve claims. The favorable development
on the 1993 accident year appears to have been aided by the workers'
compensation reforms that were enacted in July 1993 to combat the abuses in the
California workers' compensation system. There can be no assurances that
favorable development, or the magnitude of the development, will continue in the
future.
See Note 6 of Notes to Consolidated Financial Statements.
General, Administrative and Marketing Expenses. General, administrative and
marketing ("G&A") costs increased 18.4% to $63.6 million for the twelve months
ended December 31, 1995 compared to the twelve months ended December 31, 1994.
As a percentage of revenues, however, G&A costs for the twelve months ended
December 31, 1995 increased to 13.6% from 13.3% during the comparable period in
1994. Excluding the operations of HMO Texas, however, G&A as a percentage of
revenue for 1995 decreased to 12.6%. Of the $9.9 million increase in G&A,
approximately $4.8 million was due to the HMO Texas operations. Additional
increases include $3.2 million of compensation costs primarily resulting from
additional employees supporting expanded services, and $1.6 million in
additional marketing and related fees.
Income Tax. The Company's effective income tax rate for the year ended
December 31, 1995, was 30.4% compared to 18.2% for the year ended 1994. This
change is primarily due to the non-deductibility of a significant portion of the
merger costs incurred in 1995 and a $4.0 million tax benefit recorded as part of
the 1994 provision as a result of a reduction of the deferred tax valuation
allowance. See Note 8 of Notes to Consolidated Financial statements.
Discontinued Operations. During 1995, CII sold its interest in an
unprofitable subsidiary for approximately $1.0 million in cash and securities.
This disposal resulted in a loss on discontinued operations, net of tax effects,
of $6.6 million in 1995 compared to losses of $2.5 million from the discontinued
operations in 1994.
Net Income. Net income for 1995 decreased to $21.3 million, from $34.4
million in 1994. This decrease is primarily due to the non-recurring items
previously discussed, discontinued operations, merger and integration expenses,
and the change in the deferred tax valuation allowance. Excluding non-recurring
items and the related tax effects, income from ongoing operations for 1995
increased 11.9% to $36.8 million from $32.9 million in 1994.
22
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents increased by $46.5 million to
$103.6 million at December 31, 1996, from $57.0 million at December 31, 1995. At
December 31, 1996, the Company had working capital of $76.5 million. The primary
source of cash received during the year ended December 31, 1996, was operations.
The Company's cash flow from operating activities resulted in $52.4 million
of cash flow for the twelve months ended December 31, 1996. This cash flow was
primarily generated from net income of $31.1 million, $10.5 million in
depreciation and amortization, and a net change in operating assets and
liabilities, excluding cash and cash equivalents, of $10.8 million. The increase
in cash from fluctuations in such operating assets and liabilities is
principally due to increases in the reserve for losses and loss adjustment
expense, other liabilities and medical claims payable, as well as a decrease in
reinsurance recoverable. These increases in cash were offset by increases in
accounts receivable and other assets.
In 1996 the Company spent $36.3 million on the acquisition, net of cash
acquired, of Prime and the remaining interests of HMO Texas and $17.9 million in
capital expenditures. Capital expenditures were primarily for new facilities as
well as the expansion of existing medical facilities and include the
construction costs of a 59,000 square foot medical facility in Las Vegas with
completion expected in the fourth quarter of 1997, medical equipment for the
Breast Care Center and 23 hour recovery unit, remodeling of certain existing
medical space and construction costs on an additional administrative
headquarters building of approximately 180,000 square feet. Such facilities
accounted for $8.5 million of the total capital expenditures. Other capital
expenditures were primarily for business expansion of the HMO and insurance
operations, along with general corporate expansion. Such amounts include $3.2
million in computer hardware and software. In addition, the Company reduced debt
obligations by $9.6 million in 1996. Most of this debt reduction was a result of
the Company paying off a mortgage on one of the clinics. These cash outflows
were offset through the net change of marketable securities, as well as $3.6
million received in connection with the purchase of stock through the Company's
employee stock plans.
In April 1996, the Company obtained a $50.0 million unsecured line of
credit from Bank of America National Trust & Savings Association ("BofA") for a
term of five years at an interest rate equal to the London InterBank Offering
Rate ("LIBOR") plus 32 basis points. Such rate would have been 5.875% at
December 31, 1996 if the line of credit had been drawn upon.
In September 1991, CII issued convertible subordinated debentures (the
"Debentures") due September 15, 2001. The Debentures bear interest at 7 1/2%
which is due semi-annually on March 15 and September 15. Each $1,000 in
principal is convertible into 16.921 shares of the Company's common stock at a
conversion price of $59.097 per share. Unamortized issuance costs of $1.1
million are included in other assets on the balance sheet and are being
amortized over the life of the Debentures. The Debentures are general unsecured
obligations of CII only and are not guaranteed by Sierra. During the twelve
months ended December 31, 1996, the Company purchased $2.3 million of the
Debentures on the open market. At December 31, 1996, CII had total assets of
$315.9 million, consisting primarily of investments, and total liabilities of
$271.0 million, consisting primarily of reserves for losses and loss adjustment
expense and the debentures. For the year ended December 31, 1996, CII had net
premiums earned of $121.0 million and investment and other revenue of $18.7
million, and total operating expenses of $128.9 million.
The Company has a 1997 capital budget of approximately $45.0 million,
primarily for the completion of the construction on the new 59,000 square-foot
medical facility and 180,000 square foot six-story corporate headquarters
building and accompanying five-story parking structure, computer hardware and
software, furniture and equipment, and other requirements due to the Company's
projected growth and expansion. Completion of the medical facility is expected
in the fourth quarter of 1997 at an estimated cost
23
of $7.3 million. Completion of the additional building at the corporate
headquarters complex is expected in the fourth quarter of 1997 at an estimated
cost of $35.0 million, of which $3.5 million was spent in 1996. The Company's
liquidity needs over the next 12 months will primarily be for the capital items
noted above to support growing membership in Nevada, as well as debt service and
expansion of the Company's operations. The Company believes that existing
working capital, operating cash flow and, if necessary, mortgage financing and
equipment leasing, and amounts available under its credit facility will be
sufficient to fund its capital expenditures, debt service and any expansion
activities during the next 12 months. Additionally, subject to unanticipated
cash requirements, the Company believes that its existing working capital and
operating cash flow and, if necessary, its access to new credit facilities, will
enable it to meet its liquidity needs on a longer term basis.
The holding company may receive dividends from its HMO and insurance
subsidiaries which generally must be approved by certain state insurance
departments. The Company's 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 $13.6 million and $12.5
million, as of December 31, 1996 and December 31, 1995, respectively. The HMO
and insurance subsidiaries also meet requirements to maintain minimum
stockholder's equity ranging from $200,000 to $5.2 million. Of the cash and cash
equivalents held at December 31, 1996, $85.2 million is designated for use only
by the regulated subsidiaries. Such 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 terms of existing management agreements
and by dividends. Remaining amounts are available on an unrestricted basis. The
holding company will not receive dividends from its HMO or insurance
subsidiaries that would cause violation of statutory net worth and reserve
requirements.
On March 18, 1997, the Company announced it had terminated its merger
agreement with PCA. During the first quarter of 1997, the Company intends to
record certain costs and expenses incurred as a result of the terminated merger.
See Item 3. Legal Proceedings for discussion on associated litigation.
On January 10, 1997, the Company and PCA entered into a credit and share
pledge agreement (the "PCA Loan") pursuant to which the Company made a demand
loan to PCA in the amount of $16.8 million with an 8.25% fixed rate of interest.
The proceeds of the PCA Loan were used by PCA to make a principal payment under
PCA's existing credit facility in which Citibank N.A. is the agent ("PCA Credit
Facility"). The PCA Loan is subordinated as to payment of principal and interest
to the amount due under the PCA Credit Facility (estimated to be in excess of
$100 million) and is secured by a lien on the stock of certain of PCA's
subsidiaries, second in priority to the lien securing the PCA Credit Facility.
The PCA Loan provides that the Company will not take any action to collect
payment until the earlier of the PCA Credit Facility being paid in full or six
months from the date the Company notifies Citibank N.A., as agent, that it
intends to take such action. On March 20, 1997 the Company notified Citibank
N.A. of its intent to demand payment. There can be no assurance that PCA will
have sufficient funds to pay the PCA Credit Facility and the PCA Loan in full.
The Company has submitted a proposal as the prime contractor to OCHAMPUS to
provide managed health care coverage to CHAMPUS eligible beneficiaries in Region
1. This region includes approximately 665,000 individuals in Connecticut,
Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York,
Pennsylvania, Rhode Island, Vermont, northern Virginia and Washington, D.C. The
Company expects to incur expenses of approximately $8.0 to $10.0 million during
the Region 1 contract proposal process. The Company submitted its final bid on
February 14, 1997 and anticipates learning of the result of its bid in the
second quarter of 1997. The contract, if awarded to the Company, will result in
approximately $1.8 billion in estimated revenues over the term of the contract.
24
Inflation
Health care costs generally continue to rise at a faster rate than the
Consumer Price Index. The Company has been able to lessen somewhat the impact of
inflation by managing medical costs. There can be no assurance, however, that,
in the future, the Company's ability to manage medical costs will not be
negatively impacted by items such as technological advances, utilization changes
and catastrophic items, which could, in turn, result in medical cost increases
equaling or exceeding premium increases.
Health Care Reform
As a result of the continued escalation of health care costs and the
inability of many individuals to obtain health care insurance, numerous
proposals relating to health care reform have been or may be introduced in the
United States Congress and state legislatures. Any proposals affecting
underwriting practices, limiting rate increases, requiring new or additional
benefits or affecting contracting arrangements (including proposals to require
HMOs and PPOs to accept any health care providers willing to abide by an HMO's
or PPO's contract terms) may have a material adverse effect on the Company's
business.
For example, recent news reports indicate that President Clinton may submit
a budget proposal to Congress that will reduce Medicare spending by $100 billion
and impose certain limits on Medicaid spending. Although neither the present
administration's health care reform proposals nor alternative health care reform
proposals introduced by certain members of Congress were previously adopted, the
Health Insurance Portability and Accountability Act of 1996 (the "Accountability
Act") was passed by Congress and signed into law by President Clinton on August
21, 1996 and will generally take effect beginning July 1, 1997. While the
Accountability Act contains provisions regarding health insurance or health
plans, such as portability and limitations on pre-existing condition exclusions,
guaranteed availability and renewability, it also contains several anti-fraud
measures that significantly change health care fraud and abuse provisions. Some
of the provisions include (i) creation of an anti-fraud and abuse trust fund and
coordination of fraud and abuse efforts by federal, state and local authorities,
(ii) extension of the criminal anti-kickback statues to all federal health
programs, (iii) expansion of and increase in the amount of civil monetary
penalties and establishment of a knowledge standard for individuals or entities
potentially subject to civil monetary penalties, and (iv) revisions to current
sanctions for fraud and abuse, including mandatory and permissive exclusion from
participation in the Medicare or Medicaid programs. The Company does not believe
that the Accountability Act should have a material adverse effect on the
Company's operations, but is unable to predict the ultimate impact of any
federal or state restructuring of the health care financing and delivery system,
which ultimately could have a material adverse impact on the operations,
financial condition and prospects of the Company.
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
Page
Management Report on Consolidated Financial Statements.................. 27
Independent Auditors' Report............................................ 28
Consolidated Balance Sheets at December 31, 1996 and 1995............... 29
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1995, and 1994.................................... 30
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1996, 1995 and 1994................. 31
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995, and 1994.................................... 32
Notes to Consolidated Financial Statements.............................. 33
26
MANAGEMENT REPORT ON CONSOLIDATED FINANCIAL STATEMENTS
The management of Sierra Health Services, Inc., is responsible for the integrity
and objectivity of the accompanying Consolidated Financial Statements. The
statements have been prepared in conformity with generally accepted accounting
principles applied on a consistent basis and are not misstated due to fraud or
material error. The statements include some amounts that are based upon the
Company's best estimates and judgment.
The accounting systems and controls of the Company are designed to provide
reasonable assurance that transactions are executed in accordance with
management's authorization, that the financial records are reliable for
preparing financial statements and maintaining accountability for assets, and
that assets are safeguarded against losses from unauthorized use or disposition.
Management believes that for the year ended December 31, 1996, such systems and
controls were adequate to meet the objectives discussed herein.
The accompanying Consolidated Financial Statements have been audited by
independent certified public accountants, whose audits thereof were made in
accordance with generally accepted auditing standards and included a review of
internal accounting controls to the extent necessary to design audit procedures
aimed at gathering sufficient evidence to provide a reasonable basis for their
opinion on the fairness of presentation of the Consolidated Financial Statements
taken as a whole.
The Audit Committee of the Board of Directors, comprised solely of directors
from outside the Company, meets regularly with management and the independent
auditors to review the work procedures of each. The independent auditors have
free access to the Audit Committee, without management being present, to discuss
the results of their opinions on the adequacy of the Company's accounting
controls and the quality of the Company's financial reporting. The Board of
Directors, upon the recommendation of the Audit Committee, appoints the
independent auditors, subject to stockholder ratification.
Anthony M. Marlon, M.D.
Chairman and
Chief Executive Officer
James L. Starr
Vice President,
Chief Financial Officer
and Treasurer
27
INDEPENDENT AUDITORS' REPORT
Board of Directors
Sierra Health Services, Inc.:
We have audited the consolidated balance sheets of Sierra Health Services, Inc.,
and its subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1996. Our audits also
included the financial statement schedules listed in the index at Item 14
(a)(2). These financial statements and financial statement schedules are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedules based on
our audits. The consolidated financial statements give retroactive effect to the
merger of Sierra Health Services, Inc., and its subsidiaries, and CII Financial,
Inc., and its subsidiaries, which has been accounted for as a pooling of
interests as described in Note 1 to the consolidated financial statements. We
did not audit the statements of operations, stockholders' equity, and cash flows
of CII Financial, Inc., and its subsidiaries, for the year ended December 31,
1994, which statements reflect total revenues of $106,280,000 for the year ended
December 31, 1994. These statements were audited by other auditors whose report
has been furnished to us, and our opinion, insofar as it relates to the amounts
included for CII Financial, Inc., and its subsidiaries, for 1994 is based solely
on the report of such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors, the
consolidated financial statements present fairly, in all material respects, the
financial position of Sierra Health Services, Inc. and its subsidiaries at
December 31, 1996 and 1995, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1996 in
conformity with generally accepted accounting principles. Also, in our opinion,
such financial statement schedules when considered in relation to the basic
consolidated financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Las Vegas, Nevada
February 21, 1997
(March 28, 1997 as to Note 14)
28
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1996 and 1995
ASSETS
1996 1995
CURRENT ASSETS:
Cash and Cash Equivalents.............................................. $103,587,000 $ 57,044,000
Short-term Investments................................................. 83,688,000 72,579,000
Accounts Receivable (Less: Allowance for Doubtful
Accounts 1996 - $7,324,000; 1995 - $5,000,000)..................... 31,849,000 21,723,000
Current Portion of Deferred Tax Asset ................................. 13,713,000 7,629,000
Prepaid Expenses and Other Current Assets.............................. 20,098,000 16,442,000
Total Current Assets............................................... 252,935,000 175,417,000
PROPERTY AND EQUIPMENT, NET................................................ 99,804,000 91,176,000
LONG-TERM INVESTMENTS...................................................... 160,482,000 234,698,000
RESTRICTED CASH AND INVESTMENTS............................................ 13,648,000 12,482,000
REINSURANCE RECOVERABLE, Net of Current Portion............................ 14,721,000 24,952,000
GOODWILL .................................................................. 44,602,000 8,351,000
OTHER ASSETS............................................................... 43,270,000 28,070,000
TOTAL ASSETS............................................................... $629,462,000 $575,146,000
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accrued Liabilities....................................................... $ 37,650,000 $ 21,576,000
Accrued Payroll and Taxes................................................. 12,503,000 14,174,000
Medical Claims Payable.................................................... 46,969,000 37,463,000
Current Portion of Reserve for
Losses and Loss Adjustment Expense .................................. 52,878,000 54,679,000
Unearned Premium Revenue.................................................. 24,210,000 22,260,000
Current Portion of Long-term Debt......................................... 2,195,000 7,108,000
Total Current Liabilities............................................ 176,405,000 157,260,000
RESERVE FOR LOSSES AND
LOSS ADJUSTMENT EXPENSE (Less Current Portion) ........................... 134,898,000 127,639,000
LONG-TERM DEBT (Less Current Portion) ........................................ 66,189,000 71,257,000
OTHER LIABILITIES ............................................................ 17,488,000 11,275,000
TOTAL LIABILITIES............................................................. 394,980,000 367,431,000
STOCKHOLDERS' EQUITY:
Preferred Stock, $.01 Par Value, 1,000,000
Shares Authorized; None Issued or Outstanding
Common Stock, $.005 Par Value, 40,000,000
Shares Authorized; Shares Issued: 1996 --
17,910,000; 1995-- 17,677,000........................................ 89,000 88,000
Additional Paid-in Capital................................................ 152,035,000 147,240,000
Treasury Stock; 1996 and 1995 - 100,200
Common Shares........................................................ (130,000) (130,000)
Unrealized Holding Gain on Available-for-Sale Investment.................. 487,000 9,659,000
Retained Earnings......................................................... 82,001,000 50,858,000
Total Stockholders' Equity........................................... 234,482,000 207,715,000
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................... $629,462,000 $575,146,000
See the accompanying notes to consolidated financial statements.
29
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31, 1996, 1995 and 1994
1996 1995 1994
OPERATING REVENUES:
Medical Premiums............................................. $386,968,000 $319,475,000 $269,382,000
Specialty Product Revenue.................................... 133,324,000 102,807,000 101,287,000
Professional Fees............................................ 28,836,000 19,417,000 12,331,000
Investment and Other Revenue................................. 26,283,000 25,310,000 19,081,000
Total..................................................... 575,411,000 467,009,000 402,081,000
OPERATING EXPENSES:
Medical Expenses............................................. 315,915,000 245,135,000 200,229,000
Specialty Product Expenses................................... 130,758,000 102,859,000 96,600,000
General, Administrative and Marketing Expenses............... 72,237,000 63,562,000 53,671,000
Acquisition, Restructuring and Other Expenses............... 12,064,000 11,614,000
Total..................................................... 530,974,000 423,170,000 350,500,000
OPERATING INCOME.................................................. 44,437,000 43,839,000 51,581,000
OTHER INCOME (EXPENSE):
Minority Interests........................................... 2,065,000 2,471,000 (113,000)
Interest Expense and Other, Net.............................. (4,888,000) (6,208,000) (6,288,000)
Total..................................................... (2,823,000) (3,737,000) (6,401,000)
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES ......................................... 41,614,000 40,102,000 45,180,000
PROVISION FOR INCOME TAXES........................................ 10,471,000 12,198,000 8,236,000
INCOME FROM CONTINUING OPERATIONS................................. 31,143,000 27,904,000 36,944,000
NET OPERATING LOSS ON
DISCONTINUED OPERATIONS ..................................... (2,010,000) (2,501,000)
NET LOSS ON DISPOSAL OF
DISCONTINUED OPERATIONS ..................................... (4,590,000)
NET INCOME ....................................................... $ 31,143,000 $ 21,304,000 $ 34,443,000
EARNINGS PER COMMON SHARE
Income from Continuing Operations ........................... $1.76 $1.60 $2.36
Net Operating Loss on Discontinued Operations ............... (.12) (.16)
Net Loss on Disposal of Discontinued Operations ............. (.26)
Net Income Per Share .................................... $1.76 $1.22 $2.20
See the accompanying notes to consolidated financial statements.
30
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
For the Years Ended December 31, 1996, 1995 and 1994
Unrealized
(Loss)
Gain on Retained
Additional Available- Earnings Total
Common Stock Paid- In Treasury for-Sale (Accumulated Stockholders
Shares Amount Capital Stock Investments Deficit) Equity
BALANCE, JANUARY 1, 1994.................. 15,123,000 $75,000 $89,761,000 $(130,000) $(109,000) $( 4,889,000) $84,708,000
Issuance of Common Stock in
Connection with Stock Plans......... 413,000 3,000 5,112,000 5,115,000
Issuance of Common Stock
in Connection with
Public Offering, Net................... 1,800,000 9,000 44,570,000 44,579,000
Income Tax Benefit Realized Upon
Exercise of Stock Options........... 1,955,000 1,955,000
Change in Unrealized Holding Gains
(Losses), Net of Taxes .............. (2,643,000) (2,643,000)
Net Income........................ 34,443,000 34,443,000
BALANCE, DECEMBER 31, 1994............... 17,336,000 87,000 141,398,000 (130,000) (2,752,000) 29,554,000 168,157,000
Issuance of Common Stock in
Connection with Stock Plans........ 304,000 1,000 4,297,000 4,298,000
Issuance of Stock in Connection
with Acquisition .................... 37,000 87,000 87,000
Income Tax Benefit Realized Upon
Exercise of Stock Options............ 1,458,000 1,458,000
Change in Unrealized Holding Gains
(Losses), Net of Taxes............... 12,411,000 12,411,000
Net Income........................ 21,304,000 21,304,000
BALANCE, DECEMBER 31, 1995................ 17,677,000 88,000 147,240,000 (130,000) 9,659,000 50,858,000 207,715,000
Issuance of Common Stock in
Connection with Stock Plans......... 233,000 1,000 3,637,000 3,638,000
Income Tax Benefit Realized Upon
Exercise of Stock Options........... 1,158,000 1,158,000
Change in Unrealized Holding Gains
(Losses), Net of Taxes (9,172,000) (9,172,000)
Net Income........................ 31,143,000 31,143,000
BALANCE, DECEMBER 31, 1996 ......... 17,910,000 $89,000 $152,035,000 $(130,000) $ 487,000 $82,001,000 $234,482,000
See the accompanying notes to consolidated financial statements.
31
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 1996, 1995 and 1994
1996 1995 1994
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income .......................................................... $ 31,143,000 $ 21,304,000 $ 34,443,000
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Loss on Discontinued Operations ................................. 6,600,000 2,501,000
Depreciation and Amortization.................................... 10,499,000 9,505,000 8,300,000
Provision for Doubtful Accounts.................................. 3,057,000 1,694,000 2,156,000
Change in Assets and Liabilities, Net of
Effects from Acquisitions:
Other Assets..................................................... (16,301,000) (7,542,000) (2,314,000)
Reinsurance Recoverable ......................................... 10,231,000 3,349,000 (3,366,000)
Reserve for Losses and Loss Adjustment Expense 7,259,000 (5,481,000) (6,548,000)
Other Liabilities ............................................... 6,985,000 1,665,000
Minority Interests............................................... (1,746,000) (2,606,000) 511,000
Accounts Receivable.............................................. (12,469,000) (923,000) 3,837,000
Other Current Assets............................................. (4,738,000) (2,434,000) 1,341,000
Medical Claims Payable........................................... 4,973,000 6,341,000 3,858,000
Other Current Liabilities........................................ 13,553,000 5,709,000 4,743,000
Net Cash Provided by Continuing Operations ......................... 52,446,000 37,181,000 49,462,000
Net Cash Used by Discontinued Operations (2,651,000) (2,875,000)
Net Cash Provided by Operating Activities 52,446,000 34,530,000 46,587,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures................................................. (17,927,000) (20,522,000) (12,383,000)
Property and Equipment Dispositions, Net............................. 172,000 725,000 475,000
Purchase of Available-for-Sale Investments........................... (712,503,000) (368,875,000) (131,661,000)
Proceeds from Sales/Maturities of
Available-for-Sale Investments................................... 752,279,000 365,539,000 59,956,000
Purchase of Held-to-Maturity Investments (25,835,000) (11,735,000) (17,605,000)
Proceeds from Maturities of Held-to-Maturity Investments............ 39,184,000 20,183,000 7,027,000
Change in Financed Premium Receivable ............................... 15,676,000 (2,810,000)
Acquisitions, Net of Cash Acquired................................... (36,310,000) (11,023,000) (4,000,000)
Net Cash Used for Investing Activities........................... (940,000) (10,032,000) (101,001,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Long-term Borrowing.................................... 1,000,000 2,625,000 8,000,000
Payments on Debt and Capital Leases.................................. (9,601,000) (11,931,000) (8,735,000)
Proceeds from Issuance of Common Stock............................... 44,579,000
Exercise of Stock in Connection with Stock Plans..................... 3,638,000 3,807,000 4,385,000
Net Cash (Used for) Provided by Financing Activities (4,963,000) (5,499,000) 48,229,000
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS................................................. 46,543,000 18,999,000 (6,185,000)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 57,044,000 38,045,000 44,230,000
CASH AND CASH EQUIVALENTS AT END OF YEAR................................... $103,587,000 $ 57,044,000 $ 38,045,000
See the accompanying notes to consolidated financial statements.
32
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
1. BUSINESS
Business. The consolidated financial statements include the accounts of
Sierra Health Services, Inc. ("Sierra") and its subsidiaries (collectively
referred to as the "Company"). The Company is a managed health care organization
that provides and administers the delivery of comprehensive health care and
workers' compensation programs with an emphasis on quality care and cost
management. The Company's broad range of managed health care services is
provided through its health maintenance organizations ("HMOs"), managed
indemnity plans, third-party administrative services programs for
employer-funded health benefit plans and workers' compensation medical
management programs. Ancillary products and services that complement the
Company's managed health care product lines are also offered.
Acquisitions. On October 31, 1995, the Company issued approximately 2.7
million shares of its common stock in exchange for all of the outstanding common
stock of CII Financial, Inc., and subsidiaries ("CII"). In addition, all
outstanding CII stock options were converted into options to purchase up to
approximately 540,000 shares of the Company's common stock. The merger was
accounted for as a pooling of interests and, accordingly, the Company's
consolidated financial statements have been restated to include the accounts and
operations of CII for all periods prior to the merger.
In November 1996, the Company acquired complete ownership of HMO Texas, LC
("HMO Texas") for $5,040,000. The Company had previously held a 50 percent
interest in the Houston-based health plan which had approximately 12,700 members
at the end of 1996. The purchase resulted in goodwill of $5,040,000.
Effective December 31, 1996 the Company purchased Prime Holdings, Inc.
("Prime"), for approximately $32,219,000 in cash. At December 31, 1996 Prime
operated MedOne Health Plan, Inc. ("MedOne"), a 12,800 member HMO. Prime also
served 215,000 people through preferred provider organizations, workers'
compensation programs and administrative service products for self-insured
employers and union welfare trust funds, primarily in the state of Nevada. The
acquisition resulted in goodwill of $31,117,000.
The following pro forma information (unaudited) has been prepared assuming
that this acquisition had taken place at the beginning of the respective
periods. The pro forma information includes adjustments for interest expense
that would have been incurred to finance the purchase and the amortization of
intangibles arising from the transaction. The pro forma financial information is
not necessarily indicative of the results of operations as they would have been
had the transaction been effected on the assumed dates, as Prime incurred
significant startup costs associated with their HMO.
1996 1995
Operating Revenues .................................. $595,187,000 $483,507,000
Income from Continuing Operations 22,381,000 22,202,000
Net Income .......................................... 22,381,000 15,602,000
Earnings Per Common Share:
Income from Continuing Operations $1.26 $1.27
Net Income ...................................... 1.26 .90
33
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. All significant intercompany transactions and
balances have been eliminated. Sierra's wholly owned subsidiaries include Health
Plan of Nevada, Inc. ("HPN"), HMO Texas and MedOne, all licensed HMOs, Sierra
Health and Life Insurance Company, Inc. ("SHL"), a health and life insurance
company, Southwest Medical Associates, Inc. ("SMA"), a multi-specialty medical
group, CII Financial, Inc. ("CII"), a holding company primarily engaged in
writing workers' compensation insurance through its wholly owned subsidiaries,
administrative services companies, a home health care agency, a hospice and a
company that provides and manages mental health and substance abuse services.
Medical Premiums. Non-Medicare member enrollment is represented principally
by employer groups. Medical premiums are billed to each employer group in
accordance with negotiated contracts, and such premium revenue is recognized
when earned. Unearned premium revenue includes payments under prepaid Medicare
contracts with the Health Care Financing Administration ("HCFA") and prepaid
HPN, HMO Texas and MedOne commercial and SHL indemnity premiums. HPN offers a
prepaid health care program to Medicare recipients. Revenues associated with
these Medicare recipients were approximately $140,611,000, $111,584,000 and
$82,792,000, in 1996, 1995 and 1994, respectively.
Specialty Product Revenue. These revenues consist primarily of workers'
compensation premiums. Premiums are calculated by formula such that the premium
written is earned pro rata over the term of the policy. Also included in
specialty product revenues are administrative services and certain ancillary
product revenues. Such revenues are recognized in the period in which the
service is performed or the period that coverage for services is provided.
Premiums written in excess of premiums earned are recorded as an unearned
premium revenue liability. Premiums earned include an estimate for earned but
unbilled premiums.
Professional Fees. Revenue for professional medical services is recorded on
the accrual basis in the period in which the services are provided. Such revenue
is recorded at established rates net of provisions for estimated contractual and
charitable allowances.
Medical Expenses. Sierra contracts with hospitals, physicians and other
providers of health care under capitated or discounted fee-for-service
arrangements including hospital per diems to provide medical care services to
enrollees. Capitated providers are at risk for the cost of medical care services
provided to the Company's enrollees in the relevant geographic areas; however,
the Company is ultimately responsible for the provision of services to its
enrollees should the capitated provider be unable to provide the contracted
services. Health care costs are recorded in the period when services are
provided to enrolled members, including estimates for provider costs which have
been incurred as of the balance sheet date but not reported. Losses on specific
contracts, if any, are accrued when measurable.
Specialty Product Expenses. This expense consists primarily of losses and
loss adjustment expense ("LAE") and policy acquisition costs associated with
issued workers' compensation policies. Losses and LAE is based upon the
accumulation of cost estimates for reported claims occurring during the period
as well as an estimate for losses that have occurred but have not yet been
reported. Policy acquisition costs consist of commissions, premium taxes and
other underwriting costs, which are directly related to the production and
retention of new and renewal business and are deferred and amortized as the
related premiums are earned. Should it be determined that future policy revenues
and earnings on invested funds relating to existing insurance contracts will not
be adequate to cover related costs and expenses, deferred costs are expensed.
Also included in specialty product expense are costs associated with
administrative services and certain ancillary products. These costs are recorded
when incurred.
34
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
Cash and Cash Equivalents. The Company considers cash and cash equivalents
as all highly liquid instruments with a maturity of three months or less at time
of purchase. The carrying amount of cash and cash equivalents approximates fair
value because of the short maturity of these instruments.
Marketable Investments. Short- and long-term investments consist
principally of U.S. Government securities and municipal bonds, as well as
corporate and mortgage backed securities. Short-term investments have maturities
of one year or less. Long-term investments have maturities in excess of one
year.
Restricted Cash and Investments. Certain subsidiaries are required by state
regulatory agencies to maintain certain deposits and must also meet certain net
worth and reserve requirements. The Company and its subsidiaries are in
compliance with the applicable minimum regulatory and capital requirements.
Property and Equipment. Property and equipment are stated at cost.
Maintenance and repairs that do not improve or extend the life of the respective
assets are charged to operations. Depreciation and amortization is computed
using the straight-line method over the estimated service lives of the assets or
terms of leases if shorter. Estimated useful lives are as follows:
Buildings and Improvements 30 years
Leasehold Improvements 3 - 10 years
Furniture, Fixtures and Equipment 3 - 5 years
Goodwill. Goodwill has been recorded primarily as a result of various
business acquisitions by the Company. Amortization is provided on a straight
line basis over periods not exceeding 30 years. The Company evaluates the
carrying value of its intangible assets at each balance sheet date.
Medical Claims Payable. Medical claims payable includes the estimated cost
for unpaid claims for which health care services have been provided to enrollees
and a provision of the estimated costs for claims that have occurred but have
not been reported.
Reserve For Losses and Loss Adjustment Expense. The reserve for losses and
LAE consists of estimated costs of each unpaid claim reported prior to the close
of the accounting period, as well as those incurred but not yet reported. The
methods for establishing and reviewing such liabilities are continually reviewed
and adjustments are reflected in current operations.
Earnings Per Share. Earnings per common share for the years ended December
31, 1996, 1995, and 1994 have been calculated using the weighted average number
of common shares outstanding of 17,726,000, 17,414,000, and 15,678,000
respectively. Earnings per share have been restated to reflect the merger of CII
accounted for as a pooling of interests.
Income Taxes. The Company accounts for income taxes using the liability
method. Deferred income tax assets and liabilities result from temporary
differences between the tax basis of assets and liabilities and the reported
amounts in the consolidated financial statements that will result in taxable or
deductible amounts in future years. The Company's temporary differences arise
principally from certain net operating losses, accrued expenses, reserves and
depreciation.
Discontinued Operations. During 1995 CII sold its interest in a subsidiary
for a combination of common stock and warrants of the purchaser. This
transaction was recorded as a discontinued operation.
35
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
Concentration of Credit Risk. The Company's financial instruments that are
exposed to credit risk consist primarily of investments and accounts receivable.
The Company maintains cash and cash equivalents, and short- and long-term
investments with various financial institutions. These financial institutions
are located in many different geographies, and company policy is designed to
limit exposure with any one institution.
Credit risk with respect to accounts receivable is generally diversified
due to the large number of entities comprising the Company's customer base and
their dispersion across many different industries. These customers are primarily
located in the states in which the Company operates. Such operations are
principally in Arizona, California, Colorado, Nevada and Texas. However, the
Company is licensed and does business in several other states as well. The
Company performs ongoing credit evaluations of its customers' financial
condition.
Accounting for Stock-Based Compensation. Statement of Financial Accounting
Standards No. 123 ("FAS 123"), "Accounting for Stock-Based Compensation"
provides an alternative to APB Opinion No. 25 ("APB 25"). FAS 123 encourages,
but does not require, recognition against earnings of compensation expense for
grants of stock, stock options and other equity instruments by employers
(collectively, "options"), based on fair value at the date of grant. FAS 123
provides a methodology for the determination of fair value; however, FAS 123
also allows companies to continue to measure compensation cost using the
intrinsic value method of accounting provided by APB 25. FAS 123 requires
companies that choose not to adopt the new fair value accounting rules to
disclose pro forma net income and earnings per share under the new method as if
it had been adopted. The Company has continued with the intrinsic value method
prescribed in APB 25 as disclosed in Note 11.
Estimates and Assumptions. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Estimates and assumptions include, but are not
limited to, medical and specialty product expenses. Actual results may
materially differ from estimates.
Acquisition, Restructuring and Other Expenses. Acquisition, restructuring
and other expenses represent the non-recurring incremental costs the
Company has incurred in connection with various mergers, acquisitions and
planned dispositions. Costs recorded for restructurings satisfy the definitions
and criteria set forth in Emerging Issues Task Force Issue 94-3 "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)," that are
directly related to the restructurings.
Reclassifications. Certain amounts in the Consolidated Financial Statements
for the year ended December 31, 1995 and 1994 have been reclassified to conform
with the current year presentation.
36
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
3. PROPERTY AND EQUIPMENT
Property and equipment at December 31 consists of the following:
Classification 1996 1995
Land................................................... $12,224,000 $11,988,000
Buildings and Improvements............................. 58,962,000 55,796,000
Furniture, Fixtures and Equipment......................... 35,785,000 34,885,000
Data Processing Equipment and Software ................ 21,034,000 15,311,000
Leasehold Improvements................................. 4,267,000 3,545,000
Construction in Progress............................... 7,858,000 1,200,000
Less: Accumulated Depreciation ........................ (40,326,000) (31,549,000)
Net Property and Equipment......................... $99,804,000 $91,176,000
The following is an analysis of property and equipment under capital leases
by classification:
Classification 1996 1995
Building............................................... $ 245,000 $ 245,000
Data Processing Equipment and Software ................ 1,682,000 1,682,000
Furniture, Fixtures and Equipment ..................... 730,000 491,000
Less: Accumulated Depreciation......................... (1,496,000) (1,271,000)
Net Property and Equipment.......................... $1,161,000 $1,147,000
The Company capitalizes interest expense as part of the cost of
construction of facilities. Interest expense capitalized in 1996, 1995, and 1994
was $245,000, $183,000 and $119,000, respectively.
4. CASH AND INVESTMENTS
Marketable debt investments that the Company has the intention and ability
to hold to maturity are stated at amortized cost, and categorized as
held-to-maturity. The remaining marketable debt and equity investments have been
categorized as available-for-sale and as a result are stated at their fair
value. Unrealized holding gains and losses on available-for-sale securities are
included as a separate component of stockholders' equity until realized. Gross
realized gains and losses in 1996 were $6,826,000 and $4,475,000, respectively.
Realized gains and losses are calculated using the specific identification
method and are included in net income.
After the merger of CII, the Company evaluated the consolidated security
portfolio and reclassified $80,597,000 held-to-maturity investments to
available-for-sale investments. The reclassification of these investments
resulted in $5,641,000 of net unrealized gains as of December 31, 1995. Also, an
unrealized holding gain of $1,711,000 resulting from the transfer of certain
investments from available-for-sale to the held-to-maturity category was
included in the net unrealized gains section of stockholders' equity and will be
amortized over the remaining lives of the maturities.
37
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
The following table summarizes the Company's short-term, long-term and
restricted investments as of December 31, 1996:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available-for-Sale Investments:
Classified as Short-term:
U.S Government
and its Agencies..................... $ 14,410,000 $ 25,000 $ 14,435,000
Municipal Obligations......................... 36,363,000 164,000 $ 78,000 36,449,000
Corporate Bonds......................... 10,521,000 26,000 3,000 10,544,000
Other. . . . ........................... 21,902,000 66,000 211,000 21,757,000
Total Short-term..................... 83,196,000 281,000 292,000 83,185,000
Classified as Long-term:
U.S. Government
and its Agencies..................... 67,108,000 131,000 791,000 66,448,000
Municipal Obligations......................... 14,049,000 519,000 62,000 14,506,000
Corporate Bonds......................... 32,315,000 199,000 184,000 32,330,000
Other . . . . .......................... 158,000 29,000 129,000
Total Long-term...................... 113,630,000 849,000 1,066,000 113,413,000
Classified as Restricted:
U.S. Government
and its Agencies..................... 6,997,000 102,000 12,000 7,087,000
Municipal Obligations......................... 2,485,000 149,000 2,634,000
Corporate Bonds......................... 492,000 492,000
Other. . . . . . . . . . 1,797,000 1,797,000
Total Restricted .................... 11,771,000 251,000 12,000 12,010,000
Total Available-for-Sale $208,597,000 $1,381,000 $1,370,000 $208,608,000
Held-to-Maturity Investments:
Classified as Short-term:
Municipal Obligations ..................... $ 503,000 $ 6,000 $ 509,000
Classified as Long-term:
U.S. Government
and its Agencies..................... 20,644,000 28,000 $ 460,000 20,212,000
Municipal Obligations................... 6,359,000 456,000 6,815,000
Corporate Bonds......................... 20,066,000 398,000 194,000 20,270,000
Total Long-term...................... 47,069,000 882,000 654,000 47,297,000
Classified as Restricted:
Municipal Obligations................... 575,000 38,000 613,000
Corporate Bonds......................... 1,063,000 28,000 1,091,000
Total Restricted .................... 1,638,000 66,000 1,704,000
Total Held-to-Maturity ................... $ 49,210,000 $ 954,000 $ 654,000 $ 49,510,000
38
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
The following table summarizes the Company's short-term, long-term and
restricted investments as of December 31, 1995:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available-for-Sale Investments:
Classified as Short-term:
U.S Government
and its Agencies..................... $ 6,229,000 $ 6,229,000
Municipal Obligations......................... 55,317,000 $ 340,000 55,657,000
Corporate Bonds......................... 1,499,000 6,000 1,505,000
Other . . . . . ........................ 9,473,000 815,000 $ 1,250,000 9,038,000
Total Short-term..................... 72,518,000 1,161,000 1,250,000 72,429,000
Classified as Long-term:
U.S. Government
and its Agencies..................... 58,192,000 1,594,000 7,000 59,779,000
Municipal Obligations................... 85,559,000 6,125,000 16,000 91,668,000
Corporate Bonds......................... 21,397,000 815,000 47,000 22,165,000
Other . . . . .......................... 1,225,000 121,000 1,104,000
Total Long-term...................... 166,373,000 8,534,000 191,000 174,716,000
Classified as Restricted:
U.S. Government
and its Agencies..................... 5,432,000 9,000 76,000 5,365,000
Municipal Obligations................... 650,000 15,000 665,000
Corporate Bonds......................... 3,403,000 26,000 3,429,000
Other. . . . . . . . . ................. 435,000 435,000
Total Restricted .................... 9,920,000 50,000 76,000 9,894,000
Total Available-for-Sale ......... $248,811,000 $ 9,745,000 $1,517,000 $257,039,000
Held-to-Maturity Investments:
Classified as Short-term:
Municipal Obligations................... $ 150,000 $ 150,000
Total Short-term..................... 150,000 150,000
Classified as Long-term:
U.S. Government
and its Agencies..................... 22,590,000 $ 41,000 $ 5,000 22,626,000
Municipal Obligations .................. 11,482,000 773,000 12,255,000
Corporate Bonds......................... 25,910,000 63,000 3,000 25,970,000
Total Long-term...................... 59,982,000 877,000 8,000 60,851,000
Classified as Restricted:
U.S. Government
and its Agencies ................... 1,000,000 1,000,000
Municipal Obligations................... 575,000 28,000 603,000
Corporate Bonds......................... 673,000 23,000 650,000
Other . . . . . ........................ 340,000 340,000
Total Restricted .................... 2,588,000 28,000 23,000 2,593,000
Total Held-to-Maturity ........... $ 62,720,000 $ 905,000 $ 31,000 $ 63,594,000
39
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
The contractual maturities of available-for-sale short-term,
long-term and restricted investments at December 31, 1996 are shown below.
Expected maturities may differ from contractual maturities because borrowers may
have the right to call or prepay obligations.
Amortized Estimated
Cost Fair Value
Due in one year or less...................................... $ 70,629,000 $ 69,541,000
Due after one year through five years........................ 71,052,000 70,502,000
Due after five years through ten years....................... 22,733,000 24,916,000
Due after ten years.......................................... 44,183,000 43,649,000
Total................................................... $208,597,000 $208,608,000
The contractual maturities of held-to-maturity short-term, long-term and
restricted investments at December 31, 1996 were as follows:
Amortized Estimated
Cost Fair Value
Due in one year or less...................................... $ 665,000 $ 671,000
Due after one year through five years........................ 13,816,000 14,138,000
Due after five years through ten years....................... 16,762,000 16,731,000
Due after ten years.......................................... 17,967,000 17,970,000
Total................................................... $49,210,000 $49,510,000
Of the cash and cash equivalents that total $103,587,000 in the
accompanying Consolidated Balance Sheet at December 31, 1996, $85,187,000 is
limited for use only by the Company's regulated subsidiaries. Such amounts are
available for transfer to Sierra from the regulated subsidiaries only to the
extent that they can be remitted in accordance with terms of existing management
agreements and by dividends which customarily must be approved by regulating
state insurance departments. The remainder is available to Sierra on an
unrestricted basis.
5. REINSURANCE
In the normal course of business, the Company seeks to reduce potential
losses that may arise from catastrophic events that cause unfavorable
underwriting results by reinsuring certain levels of such risk with other
reinsurers. Amounts recoverable from reinsurers are estimated in a manner
consistent with the claim liability associated with the reinsurance policy.
The Company is covered under a medical reinsurance agreement that provides
coverage for 50-90% of hospital costs in excess of $75,000 per case, up to a
maximum of $2,000,000 per member per lifetime for both the managed indemnity and
HMO subsidiaries. Reinsurance premiums of $3,235,000, $2,827,000 and $2,234,000,
net of reinsurance recoveries of $2,276,000, $1,133,000 and $584,000, are
included in medical expense for 1996, 1995 and 1994, respectively. In addition,
SHL maintains reinsurance on certain other insurance products.
40
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
CII also has reinsurance treaties in effect. The reinsurers have assumed
the liability on that portion of workers' compensation claims between $350,000
and $60,000,000 per occurrence for 1996 and between $250,000 and $60,000,000 per
occurrence for 1995 and 1994. At December 31, 1996 and 1995, the amount of
reinsurance recoverable for unpaid losses and loss adjustment expense was
$15,676,000 and $25,871,000, respectively. The amount of reinsurance receivable
for paid losses and loss adjustment expense was $103,000 and $73,000,
respectively.
Reinsurance contracts do not relieve the Company from its obligations to
enrollees or policyholders. Failure of reinsurers to honor their obligations
could result in losses to the Company. The Company evaluates the financial
condition of its reinsurers to minimize its exposure to significant losses from
reinsurer insolvencies. All reinsurers that the Company has reinsurance
contracts with are rated A+ or better by the A.M. Best Company.
The following table provides workers' compensation reinsurance information
by reinsurer for the three years ended December 31, 1996:
Change in
Recoveries Recoverable
on Paid on Unpaid Premiums
Losses/LAE Losses/LAE Ceded
1996:
General Reinsurance Corporation............... $3,076,000 $(10,195,000) $4,713,000
Others ....................................... 456,000
Total ........................................ $3,076,000 $(10,195,000) $5,169,000
1995:
General Reinsurance Corporation............... $2,426,000 $ (3,472,000) $3,727,000
Others ....................................... 300,000
Total ........................................ $2,426,000 $ (3,472,000) $4,027,000
1994:
General Reinsurance Corporation............. $1,117,000 $ 3,501,000 $3,679,000
Others ....................................... 205,000
Total ........................................ $1,117,000 $ 3,501,000 $3,884,000
41
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
6. LOSSES AND LOSS ADJUSTMENT EXPENSES
The following table provides a reconciliation of the beginning and ending
reserve balances for unpaid LAE. There can be no assurances that favorable
development, or the magnitude of the development, will continue in the future.
Year ended December 31,
1996 1995 1994
Net Beginning Losses and LAE Reserve ........................................... $156,447,000 $161,620,000 $174,515,000
Net Provision for Insured Events Incurred in:
Current Year .......................................... 101,401,000 75,978,000 67,642,000
Prior Years............................................ (15,284,000) (20,079,000) (13,953,000)
Total Net Provision.................................. 86,117,000 55,899,000 53,689,000
Net Payments for Losses and LAE
Attributable to Insured Events Incurred in:
Current Year .......................................... 24,733,000 16,553,000 16,374,000
Prior Years............................................ 45,731,000 44,519,000 50,210,000
Total Net Payments .................................. 70,464,000 61,072,000 66,584,000
Net Ending Losses and LAE Reserve ........................ 172,100,000 156,447,000 161,620,000
Reinsurance Recoverable .................................. 15,676,000 25,871,000 29,342,000
Gross Ending Losses and LAE Reserve...................... $187,776,000 $182,318,000 $190,962,000
42
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
7. LONG-TERM DEBT
Long-term debt at December 31 consists of the following:
1996 1995
7 1/2% Convertible Subordinated Debentures $54,497,000 $56,800,000
7 3/8% Mortgage Note ............................................... 7,833,000 9,802,000
Adjustable Rate Mortgage Note ....................................... 3,167,000 3,213,000
Other................................................................ 2,887,000 8,550,000
Total.............................................................. 68,384,000 78,365,000
Less Current Portion................................................. (2,195,000) (7,108,000)
Long-term Debt....................................................... $66,189,000 $71,257,000
7 1/2% Convertible Subordinated Debentures. In September 1991 CII issued
convertible subordinated debentures (the "Debentures") due September 15, 2001.
The Debentures bear interest at 7-1/2% which is due semi-annually on March 15
and September 15. Each $1,000 in principal is convertible into 16.921 shares of
the Company's common stock at a conversion price of $59.097 per share.
Unamortized issuance costs of $1,114,000 are included in other assets on the
balance sheet and are being amortized over the life of the Debentures. Accrued
interest on the Debentures as of December 31, 1996 and 1995 was $1,192,000 and
$1,243,000, respectively. The Debentures are redeemable by CII, in whole or in
part, at redemption prices ranging from 103.00% in 1997 to 100.75% in 2000, plus
accrued interest for the twelve month period beginning September 15 of the
applicable year. The Debentures are general unsecured obligations of CII only
and were not assumed or guaranteed by Sierra. During the twelve months ended
December 31, 1996, the Company purchased $2,303,000 of the debentures on the
open market.
7 3/8% Mortgage Note. In December 1993, the Company obtained a loan from
Bank of America, Nevada. This loan is secured by a deed of trust, assignment of
rents and leases, and a security agreement and fixture filing covering the
Company's administrative headquarters complex and underlying real property.
Adjustable Rate Mortgage Note. The Company has a mortgage which has an
adjustable rate with an interest margin of 3% over the Federal Home Loan Bank
Board 11th District Cost of Funds Index, a maximum interest rate of five
percentage points above the initial rate of 11.85% and a minimum interest rate
of 8%. The interest rate at December 31, 1996 was 8%. This mortgage is secured
by a medical facility.
Other. The Company has obligations under capital leases with interest rates
from 7.8% to 15.6%. In addition, the Company has a term loan due July 1998
including cumulative interest at 7%. During 1994, the Company assumed a
$4,860,000 mortgage note in conjunction with a related party transaction.
Monthly installments of $36,144, including interest at 7.12%, were due through
July 1996, at which time the balance of the note was paid.
43
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
In April 1996, the Company obtained a $50.0 million unsecured line of
credit from Bank of America National Trust & Savings Association ("BofA") for a
term of five years at an interest rate equal to the LIBOR plus 32 basis points.
Such rate would have been 5.875% at December 31, 1996 if the line of credit had
been drawn upon.
Scheduled maturities of the Company's notes payable and future minimum
payments under capital leases, together with the present value of the net
minimum lease payments at December 31, 1996, are as follows:
Obligations
Notes Under Capital
Year ending December 31, Payable Leases
1997................................................. $ 1,887,000 $371,000
1998................................................. 2,058,000 252,000
1999................................................. 7,010,000 154,000
2000................................................. 2,000,000 135,000
2001................................................. 54,497,000 31,000
Thereafter........................................... 336,000
Total............................................. $67,452,000 1,279,000
Less: Amounts Representing Interest................. 347,000
Present Value of Minimum Lease Payments.............. $932,000
The fair value of the Debentures at December 31, 1996 was $48,502,000,
which was determined based on the quoted market price at December 31, 1996.
Excluding the Debentures, the fair value of long-term debt, including the
current portion, is $13,582,000, based on the borrowing rates currently
available to the Company for bank loans with similar terms and average
maturities.
44
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
8. INCOME TAXES
A summary of the provision for income taxes for the years ended December 31
is as follows:
1996 1995 1994
Provision for Income Taxes:
Current.................................. $11,860,000 $11,736,000 $11,031,000
Deferred................................. (1,389,000) 462,000 (2,795,000)
$10,471,000 $12,198,000 $ 8,236,000
The following reconciles the difference between the 1996, 1995 and 1994
current and statutory provision for income taxes:
1996 1995 1994
Statutory Rate .................................. 35% 35% 35%
Tax Preferred Investments ....................... (6) (9) (5)
Change in Valuation Allowance ................... (6) (2) (9)
Non-deductible Acquisition Costs ................ 5
Other ........................................... 2 1 (3)
Provision for Income Taxes ................... 25% 30% 18%
45
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
The tax effects of significant items comprising the Company's net deferred
tax assets are as follows:
1996 1995
Deferred Tax Assets:
Medical and Losses and LAE Reserves ............................... $ 5,277,000 $ 7,147,000
Accruals Not Currently Deductible......................... 5,334,000 2,254,000
Vacation and Deferred Compensation................................. 2,960,000 2,485,000
Bad Debt Allowances....................................... 2,946,000 1,637,000
Loss Carryforwards and Credits............................ 13,389,000 12,202,000
Other .................................................... 803,000 744,000
30,709,000 26,469,000
Deferred Tax Liabilities:
Deferred Policy Acquisition Costs ................................. 613,000 647,000
Depreciation and Amortization ............................ 4,102,000 3,164,000
Other .................................................... 825,000 1,021,000
5,540,000 4,832,000
Net Deferred Tax Asset Before
Valuation Allowance.................................... 25,169,000 21,637,000
Valuation Allowance ...................................... (10,929,000) (12,039,000)
Net Deferred Tax Asset ................................... $14,240,000 $ 9,598,000
At December 31, 1996, the Company had approximately $30,100,000 of regular
tax net operating loss carryforwards which are limited to use at the rate of
approximately $6,600,000 per year during the carryforward period. The net
operating loss carryforwards can be used to reduce future taxable income until
they expire through the year 2011. The Company has alternative minimum tax net
operating loss carryforwards of approximately $11,000,000 which expire through
the year 2011. The Company also has California net operating loss carryforwards
of approximately $15,900,000 which expire through the year 2001. In addition to
these net operating loss carryforwards, the Company has alternative minimum tax
credits of approximately $800,000 which can be used to reduce regular tax
liabilities in future years. There is no expiration date for the alternative
minimum tax credits. The majority of the above items are subject to both annual
and separate company limitations required by the Internal Revenue Code.
Due to the above referenced limitations, a valuation allowance has been set
up to reflect the Company's inability to use tax benefits from recent
acquisitions currently or in the near future. As the benefits are realizable by
the Company, the valuation allowance will be reduced as required by Statement of
Financial Accounting Standards No. 109 "Accounting for Income Taxes" ("FAS
109"). For the years ended December 31, 1996 and 1995, the Company was able to
realize a portion of the tax benefits previously allowed for. As a result, the
Company reduced its valuation allowance by $2,685,000 and $750,000 for the years
ended December 31, 1996 and 1995, respectively. In addition, the Company
recorded a $1,575,000 valuation allowance in connection with the acquisition of
Prime on a gross deferred tax asset of $5,300,000. The valuation allowance of
$10,929,000 at December 31, 1996 is necessary under the more likely than not
criteria required by FAS 109.
46
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
9. COMMITMENTS AND CONTINGENCIES
Ongoing Initiatives. On February 14, 1997, the Company submitted its final
bid to be the prime contractor to the Civilian Health and Medical Program of the
Uniformed Services ("CHAMPUS") to provide managed health care coverage to
CHAMPUS eligible beneficiaries in Region 1. This region includes approximately
665,000 individuals in Connecticut, Delaware, Maine, Maryland, Massachusetts,
New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Vermont,
northern Virginia and Washington, D.C. The Company expects to incur total
expenses of approximately $8,000,000 to $10,000,000 during the Region 1 contract
proposal process. The Company submitted its final bid on February 14, 1997 and
anticipates learning of the result of its bid in the second quarter of 1997. The
contract, if awarded to the Company, will result in approximately $1.8 billion
in estimated revenues over the term of the contract.
Leases. The Company is the lessee under several operating leases, most of
which relate to office facilities and equipment. The rentals on these leases are
charged to expense over the lease term as the Company becomes obligated for
payment and, where applicable, provide for rent escalations based on certain
costs and price index factors. The following is a schedule, by year, of the
future minimum lease payments under existing operating leases:
Year Ending December 31,
1997................................................... $ 6,896,000
1998................................................... 5,854,000
1999................................................... 4,297,000
2000................................................... 2,929,000
2001................................................... 2,455,000
Thereafter............................................. 7,221,000
Total............................................. $29,652,000
Rent expense totaled $6,374,000, $4,942,000 and $4,873,000 in 1996,
1995 and 1994, respectively.
Litigation and Legal Matters. The Company is subject to legal proceedings
and claims that arise in the ordinary course of business. In the opinion of
management, the amount of ultimate liability with respect to these legal
proceedings will not materially impact the consolidated financial statements of
the Company.
See Note 14 "Subsequent Events".
10. EMPLOYEE BENEFIT PLANS
Defined Contribution Plan. The Company has a defined contribution pension
and 401(k) plan (the "Plan") for its employees. The Plan covers all employees
who meet certain age and length of service requirements. The Company contributes
2% of eligible employees' compensation and matches 50% of a participant's
elective deferral up to a maximum of either 10% of an employee's compensation or
the maximum allowable under current IRS statute. Prior to the merger, CII
maintained a 401(k) plan as well. As part of the merger of CII, the CII plan was
frozen in November 1995. The Company merged the two plans during 1996. Expense
under both Sierra plans totaled $3,216,000, $2,516,000 and $2,573,000 in 1996,
1995 and 1994, respectively.
47
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
Supplemental Retirement Plan. The Company has Supplemental Retirement Plans
(the "SRPs") for certain officers, directors and highly compensated employees.
The SRPs are non-qualified deferred compensation plans through which
participants may elect to postpone the receipt and taxation of all or a portion
of their salary and bonuses received from the Company. The Company also matches
50% of those contributions that participants are restricted from deferring, if
any, under the Company's pension and 401(k) plan. As contracted with the
Company, the participants or their designated beneficiaries may begin to receive
benefits under the SRPs upon participant death, disability, retirement,
termination of employment or certain other circumstances including financial
hardship.
Other CII Plans. Prior to the acquisition of CII, CII maintained various
supplemental benefit, executive benefit, and profit sharing plans. Subsequent to
the merger all such plans have been, or are in the process of being,
discontinued, terminated, or merged into the Company's existing plans. During
the years ended December 31, 1995 and 1994, CII expensed $1,574,000 and
$2,485,000, respectively, under the various plans. Eligible CII employees are
included in the Company's plans discussed above.
11. CAPITAL STOCK PLANS
Stockholders' Rights Plan. On June 14, 1994, the Board of Directors of
Sierra authorized and declared a dividend distribution of one right (a "Right")
for each share of Sierra common stock, par value $.005 per share. The Rights
were distributed to the holders of record of Common Shares at the close of
business on June 30, 1994. Each Right entitles the registered holder to purchase
from Sierra a unit consisting of one one-hundredth of a share of the Series A
Junior Participating Preferred Shares (a "Unit"), par value $.01 per share, of
Sierra, or a combination of securities and assets of equivalent value, at a
purchase price of $100.00 per Unit, subject to adjustment. The Rights have
certain anti-takeover effects. The Rights will cause substantial dilution to a
person or group that attempts to acquire Sierra on terms not approved by
Sierra's Board of Directors, except pursuant to an offer conditioned on a
substantial number of Rights being acquired. The Rights should not interfere
with any merger or other business combination approved by the Board of Directors
since Sierra may redeem the Rights at the price of $.02 per Right prior to the
time that a person or group has acquired beneficial ownership of 20% or more of
Sierra common stock.
Stock Option Plans. During 1995 the shareholders of the Company approved
the 1995 Long-Term Incentive Plan ("LTIP"). The LTIP provides for the granting
of Options, Stock, and other stock-based awards. Under the LTIP 1.2 million
shares were reserved along with remaining shares reserved from certain previous
stock option and capital accumulation plans which have not been and will not be
issued under those plans. Awards are granted by a committee appointed by the
Board of Directors. Options become exercisable at such times and in such
installments as set by the committee. Under this plan, the exercise price of
each option equals the market price of the Company's stock on the date of grant.
Options currently granted under the LTIP vest for the employees at a rate of
20-25% per year. Options expire one year after the end of the vesting period.
In addition, in 1995 the shareholders of the Company approved the 1995
Non-Employee Directors' Stock Plan ("Directors' Plan"). Under the Directors'
Plan non-employee directors are granted an option to purchase 3,000 shares of
common stock. Options are granted annually on January 20 at the current fair
market value and become exercisable over a five year period. The Company
reserved 60,000 shares under the Directors' Plan.
48
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
The following table reflects the activity of the stock option plans:
Number of Option
Shares Price
Outstanding January 1, 1994............................... 1,434,000 $ .81 - $27.03
Granted.................................. 198,000 14.53 - 28.63
Exercised................................ (355,000) 3.38 - 21.00
Canceled................................. (5,000) 3.38 - 21.00
Outstanding December 31, 1994............................. 1,272,000 2.44 - 28.63
Granted.................................. 882,000 14.86 - 31.75
Exercised................................ (241,000) 2.44 - 21.00
Canceled................................. (53,000) 3.38 - 28.63
Outstanding December 31, 1995............................. 1,860,000 3.38 - 31.75
Granted.................................. 320,000 25.00 - 35.00
Exercised................................ (166,000) 3.38 - 28.63
Canceled................................. (15,000) 10.69 - 31.75
Outstanding December 31, 1996 1,999,000 7.50 - 35.00
Exercisable at December 31, 1996 ......................... 803,000 7.50 - 31.75
Available for Grant at
December 31, 1996 ....................... 643,000
The following table summarizes information about stock options outstanding
at December 31, 1996:
Number Weighted-Average
Range of Exercise Outstanding at Remaining Weighted-Average
Prices 12-31-96 Contractual Life Exercise Price
$ 7.50 - $10.69 92,000 487 Days $ 9.88
12.00 - 16.38 316,000 943 Days 15.92
17.56 - 25.13 1,159,000 1,588 Days 23.47
26.38 - 35.00 432,000 1,658 Days 29.82
Employee Stock Purchase Plan. The Company has an employee stock purchase
plan (the "Purchase Plan") whereby employees may purchase newly-issued shares of
stock through payroll deductions at 85% of the fair market value of such shares
on specified dates as defined in the Purchase Plan. As of December 31, 1996, the
Company had 423,321 shares reserved for purchase under the Purchase Plan. During
1996, a total of 67,997 shares were purchased at prices of $20.83 and $26.45 per
share. During January 1997, 38,094 shares were issued to employees at $20.93 per
share in connection with the Purchase Plan.
49
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
Accounting for Stock-Based Compensation. At December 31, 1996, the Company
had three stock- based compensation plans, which are described above. The
Company applies APB 25 and related Interpretations in accounting for its plans.
Accordingly, no compensation cost has been recognized for its fixed stock option
plans nor the Purchase Plan. Had compensation cost for the Company's three
stock- based compensation plans been determined based on the fair value at the
grant dates for awards under those plans consistent with the method of FAS 123,
the Company's net income and earnings per share would have been reduced to the
pro forma amounts indicated below:
1996 1995
Net Income As reported $31,143,000 $21,304,000
Pro forma 29,703,000 20,203,000
Net Income Per Share As reported $1.76 $1.22
Pro forma 1.68 1.16
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1995 and 1996, respectively: dividend yield of 0%
for all years; expected volatility of 34% and 29%; risk-free interest rates of
6.12% and 5.92%; and expected lives of four years for all years. The weighted
fair value of options granted in 1995 and 1996 was $9.49 and $8.47,
respectively.
The fair value of the look-back option implicit in each offering of the
Purchase Plan is estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions used for grants in
1995 and 1996, respectively: dividend yield of 0% for all years; expected
volatility of 34% and 29%; risk-free interest rates of 6.07% and 5.29%; and
expected lives of six months for all years.
Due to the fact that the Company's stock option programs vest over many
years and additional awards are made each year, the above pro forma numbers are
not indicative of the financial impact had the disclosure provisions of FAS 123
been applicable to all years of previous option grants. The above numbers do not
include the effect of options granted prior to 1995.
50
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
12. STATEMENTS OF CASH FLOWS SUPPLEMENTAL INFORMATION
Supplemental statements of cash flows information for the years ended
December 31, is presented below:
1996 1995 1994
Cash Paid During the Year for Interest
(Net of Amount Capitalized)............................... $5,275,000 $ 6,430,000 $ 6,433,000
Cash Paid During the Year for Income Taxes.................... 7,966,000 10,509,000 9,650,000
Noncash Investing and Financing Activities:
Liabilities Assumed in Connection with
Corporate Acquisitions................................. 7,890,000 3,113,000 7,279,000
Reductions to Funds Withheld by Ceding
Insurance Company and Future
Policy Benefits........................................ 773,000 990,000 447,000
Stock Issued for Exercise of Options
and Related Tax Benefits............................... 1,158,000 1,949,000 2,685,000
Assumption of Liability in Connection with
Land Purchase ......................................... -- 1,956,000 --
Additions to Capital Leases............................... -- 278,000 552,000
Stock and Warrants Received on Sale
of Discontinued Operations ............................ -- 1,000,000 --
13. ACQUISITION, RESTRUCTURING AND OTHER EXPENSES
During 1995, as part of the Company's clinical expansion and growth
efforts, the Company acquired a medical facility in Mohave County, Arizona,
across the border from Laughlin, Nevada. This medical facility included a 12 bed
hospital. During 1996 the Company implemented a plan to exit the hospital
business and has actively pursued buyers for this business. As a result of this
plan, the Company recorded a charge of $3,814,000 ($2,860,000 after tax) in the
fourth quarter of 1996, primarily to recognize the estimated costs to dispose of
the hospital.
As a result of higher than expected claim and administrative costs
relative to premium rates that can be obtained in certain regional insurance
operations and the Company's inability to negotiate adequate provider contracts
due to its limited presence in some of these markets, the Company adopted a plan
to restructure certain insurance operations during the third quarter of 1996 and
recorded a charge of $8,250,000 ($6,187,000 after tax). The plan will allow the
Company to focus on more favorable operating markets and improve operating
efficiencies. The Company believes that this restructuring, over time, will
result in improved cash flow and operating cost savings.
These restructuring costs included cancellation of certain
contractual obligations of $6,000,000, lease termination costs of $1,500,000 and
approximately $4,564,000 of other costs including the estimated costs to dispose
of the hospital. As of December 31, 1996, approximately $4,100,000 of these
costs had been paid or otherwise charged against the accrual and the Company
estimates that most of the remaining cash expenditures will be paid over the
next twelve months.
51
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
In connection with the merger and integration of CII, $11,614,000 of
costs and expenses ($9,677,000 after tax) were incurred and charged to expense
in the fourth quarter of 1995. These costs include $6,400,000 in professional
fees, $1,700,000 for the write-off of certain redundant hardware and software,
$1,300,000 for the cancellation of certain contractual obligations and other
settlement costs, $900,000 related to transition and severance-related payments
and approximately $1,314,000 for other integration costs.
14. SUBSEQUENT EVENTS
On March 18, 1997, the Company announced it had terminated its merger
agreement with Physician Corporation of America ("PCA"). The original agreement
had been entered into in November 1996. On March 18, 1997, prior to termination
of the merger agreement, PCA filed a lawsuit against the Company in the United
States District Court for the Southern District of Florida (the "District
Court"), seeking, among other things, specific performance of the merger
agreement and monetary damages. While the Company believes the PCA lawsuit is
without merit, there can be no assurance as to the outcome of the PCA lawsuit.
The Company has filed a motion in the District Court seeking a dismissal of the
PCA lawsuit for lack of diversity jurisdiction. The Company has also initiated a
lawsuit in the Court of Chancery of the State of Delaware seeking a declaratory
judgment as well as other remedies. The Company intends to vigorously pursue all
remedies available to it, however, there can be no assurance that the Company
will prevail in such litigation or that PCA will have sufficient funds to pay
any damages that the Company may be awarded. During the first quarter of 1997
the Company intends to record certain costs and expenses incurred as a result of
the terminated merger.
On January 10, 1997, the Company and PCA entered into a credit and
share pledge agreement (the "PCA Loan") pursuant to which the Company made a
demand loan to PCA in the amount of $16,750,000 with an 8.25% fixed rate of
interest. The proceeds of the PCA Loan were used by PCA to make a principal
payment under PCA's existing credit facility in which Citibank N.A. is the agent
("PCA Credit Facility"). The PCA Loan is subordinated as to payment of principal
and interest to the amount due under the PCA Credit Facility (estimated to be in
excess of $100,000,000) and is secured by a lien on the stock of certain of
PCA's subsidiaries, second in priority to the lien securing the PCA Credit
Facility. The PCA Loan provides that the Company will not take any action to
collect payment until the earlier of the PCA Credit Facility being paid in full
or six months from the date the Company notifies Citibank N.A., as agent, that
it intends to take such action. On March 20, 1997 the Company notified Citibank
N.A. of its intent to demand payment. There can be no assurance that PCA will
have sufficient funds to pay the PCA Credit Facility and the PCA Loan in full.
52
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended December 31, 1996, 1995 and 1994
15. UNAUDITED QUARTERLY INFORMATION
(In thousands, except per share data)
March June September December
31 30 30 31
Year Ended December 31, 1996:
Operating Revenues.............................. $136,012 $141,362 $146,245 $151,792
Operating Income................................ 14,375 14,250 6,137 9,675
Income From Continuing Operations
Before Income Taxes ......................... 13,566 13,688 5,422 8,938
Net Income...................................... 10,164 10,211 4,067 6,701
Earnings Per Share ............................. .58 .58 .23 .38
Year Ended December 31, 1995:
Operating Revenues.............................. $108,272 $111,743 $115,616 $131,378
Operating Income................................ 12,822 12,777 14,430 3,810
Income From Continuing Operations
Before Income Taxes ......................... 11,786 11,694 13,727 2,895
Net Income...................................... 7,675 3,260 9,699 670
Earnings Per Share ............................. .44 .19 .56 .04
53
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information set forth under the caption "Election of Directors" in
Sierra's Proxy Statement for its 1997 Annual Meeting of Stockholders, is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information set forth under the caption "Compensation of Executive
Officers" in Sierra's Proxy Statement for its 1997 Annual Meeting of
Stockholders, is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in Sierra's Proxy Statement for its 1997
Annual Meeting of Stockholders, is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information set forth under the caption "Certain Relationships and
Related Transactions" in Sierra's Proxy Statement for its 1997 Annual Meeting of
Stockholders, is incorporated herein by reference.
54
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The following consolidated financial statements are included in Part II,
Item 8 of this Report:
Page
Independent Auditors' Report..................................... 28
Consolidated Balance Sheets at December 31, 1996 and 1995 ....... 29
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1995 and 1994.............................. 30
Consolidated Statements of Changes in Stockholders' Equity
for the Years Ended December 31, 1996, 1995 and 1994 ......... 31
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1995 and 1994.............................. 32
Notes to Consolidated Financial Statements....................... 33
The Independent Auditors' Report for a Predecessor Company
for the Year Ended December 31, 1994 is included in Exhibit 13
(a)(2) Financial Statement Schedules:
Schedule I - Condensed Financial
Information of Registrant ................................... S-1
Schedule V - Supplemental Information Concerning
Property-Casualty Insurance .................................. S-4
Section 403.04 b - Reconciliation of Beginning and Ending Loss
and Loss Adjustment Expense Reserves
and Exhibit of Redundancies (Deficiencies).. S-5
All other schedules are omitted because they are not applicable, not required,
or because the required information is in the consolidated financial statements
or notes thereto.
(a)(3)and (c) The following exhibits are filed as part of, or incorporated
by reference into, this Report as required by Item 601 of Regulation
S-K:
(3.1) Articles of Incorporation, together with amendments thereto to
date, incorporated by reference to the Registrant's Annual Report
on Form 10-K for the fiscal year ended December 31, 1990.
(3.2) Certificate of Division of Shares into Smaller Denominations of
the registrant, incorporated by reference to Exhibit 3.3 to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1992.
(3.3) Amended and Restated Bylaws of the Registrant, as amended through
March 22, 1995, incorporated by reference to Exhibit 3.3 to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1994.
55
(4.1) Rights Agreement, dated as of June 14, 1994, between the
registrant and Continental Stock Transfer & Trust Company,
incorporated by reference to Exhibit 3.4 to the Registrant's
Registration Statement on Form S-3 effective October 11, 1994
(Reg. No. 33-83664).
(4.2) Specimen Common Stock Certificate, incorporated by reference to
Exhibit 4(e) to the Registrant's Registration Statement on Form
S-8 as filed and effective on August 5, 1994 (Reg. No. 33-82474).
(4.3) Form of Indenture, of 7 1/2% convertible subordinated debentures
due 2001 from CII Financial, Inc. to Manufacturers Hanover Trust
Company as Trustee dated September 15, 1991, incorporated by
reference to Exhibit 4.2 of Post-Effective Amendment No. 1 on
Form S-3 to Registration Statement on Form S-4 dated October 6,
1995 (Reg. No. 33-60591).
(4.4) First Supplemental Indenture between CII Financial, Inc., Sierra
Health Services, Inc. and Chemical Bank as Trustee, dated as of
October 31, 1995, to Indenture dated September 15, 1991,
incorporated by reference to Exhibit 4.3 of Post-Effective
Amendment No. 2 on Form S-3 to Registration Statement on Form S-4
dated October 31, 1995 (Reg. No. 33-60591).
(10.1) Administrative Services agreement between Health Plan of Nevada,
Inc. and the Registrant dated December 1, 1987, incorporated by
reference to Exhibit 10.17 to Registrant's Annual Report on Form
10-K for the fiscal year ended December 31, 1991.
(10.2) Administrative Services agreement between Sierra Health and Life
Insurance Company, Inc. and the Registrant dated April 1, 1989,
incorporated by reference to Exhibit 10.18 to Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1991.
(10.3) Agreement between Health Plan of Nevada, Inc. and the United
States Health Care Financing Administration dated July 24, 1992,
incorporated by reference to Exhibit 10.18 to the Registrant's
Annual Report on Form 10-K filed for the fiscal year ended
December 31, 1992.
(10.4) Loan Agreement among Bank of America, Nevada, the Registrant,
Health Plan of Nevada, Inc. and Sierra Health and Life Insurance
Company, Inc. dated November 30, 1993 in the principal amount of
$14,000,000, incorporated by reference to Exhibit 10.19 to the
Registrant's Annual Report on Form 10-K for the fiscal year ended
December 31, 1993.
(10.5) Loan Agreement between Home Federal Savings and Loan Association
and 2314 West Charleston Partnership dated September 15, 1989 in
the principal amount of $3,400,000, incorporated by reference to
Exhibit 10.22 to the Registrant's Annual Report on Form 10-K for
the fiscal year ended December 31, 1992.
(10.6) Assumption and Reaffirmation Agreements dated March 25, 1994,
incorporated by reference to Exhibit 10.23 to the Registrant's
Annual Report on Form 10-K for the fiscal year ended December 31,
1993.
(10.7) Unconditional Guarantees dated March 25, 1994, incorporated by
reference to Exhibit 10.24 to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1993.
56
(10.8) Compensatory Plans, Contracts and Arrangements.
(1) Employment Agreements with Anthony M. Marlon, M.D.; Erin E.
MacDonald; Frank E. Collins; William R. Godfrey; Lawrence S.
Howard; Michael A. Montalvo; Jerry D. Reeves, M.D.; Marie H.
Soldo; and James L. Starr with various dates, incorporated
by reference to Exhibit 10 to the Registrant's Quarterly
Report on Form 10-Q for the fiscal quarter ended September
30, 1994.
(2) The Registrant's Second Amended and Restated 1986 Stock
Option Plan as amended to date, incorporated by reference to
Exhibit 10.24 to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1992.
(3) The Registrant's Second Restated Capital Accumulation Plan,
as amended to date, incorporated by reference to Exhibit
10.24 to the Registrant's Annual Report on Form 10-K for the
fiscal year ended December 31, 1992.
(4) The Registrant's Supplemental Retirement Plan, as amended to
date, incorporated by reference to Exhibit 10.24 to the
Registrant's Annual Report on Form 10-K for the fiscal year
ended December 31, 1992.
(5) The Registrant's Deferred Compensation Plan, as amended,
effective May 1, 1996.
(6) Protocols for cash bonus awards, incorporated by reference
to Exhibit 10.17 (5) to the Registrant's Annual Report on
Form 10-K for the fiscal year ended December 31, 1994.
(7) The Company's Long-Term Incentive Plan incorporated by
reference to Form S-8 filed July 7, 1995.
(8) The Company's 1995 Non-Employee Directors' Stock Plan
incorporated by reference to Form S-8 filed July 7, 1995.
(10.9) Agreement and Plan of Merger dated as of June 12, 1995 among
the Registrant, Health Acquisition Corp., and CII Financial,
Inc., incorporated by reference to the Report on Form 8-K
dated June 13, 1995, as amended.
(10.10) Agreement between the Registrant and First Option Health Plan
to develop and implement a Medicare risk product in New
Jersey dated January 6, 1995, incorporated by reference to
Exhibit 10.20 to the Registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 1994.
(11) Computation of earnings per share.
(13) Independent Auditors' Report for CII Financial, Inc. for the
year ended December 31, 1994.
57
(21) Subsidiaries of the Registrant (listed herein):
There is no parent of the Registrant. The following is a
listing of the active subsidiaries of the Registrant:
Jurisdiction of
Incorporation
Sierra Health and Life Insurance Company, Inc. California
Health Plan of Nevada, Inc. Nevada
Sierra Healthcare Options, Inc. and Subsidiary Nevada
Behavioral Healthcare Options, Inc. Nevada
Family Health Care Services Nevada
Family Home Hospice, Inc. Nevada
Southwest Medical Associates, Inc. Nevada
Sierra Medical Management, Inc. and Subsidiaries Nevada
Southwest Realty, Inc. Nevada
Sierra Health Holdings, Inc. (HMO Texas, L.C.) Texas
Sierra Texas Systems, Inc. Texas
CII Financial, Inc., and Subsidiaries California
Northern Nevada Health Network, Inc. Nevada
Intermed, Inc. Arizona
Prime Holdings, Inc. and Subsidiaries Nevada
(23.1) Consent of Deloitte & Touche LLP
(23.2) Consent of BDO Seidman LLP
(27) Financial Data Schedule
(99) Registrant's current report on Form 8-K dated March 28, 1997,
incorporated herein.
All other Exhibits are omitted because they are not
applicable.
(b) Reports on Form 8-K
(d) Financial Statement Schedules
The Exhibits set forth in Item 14 (a)(2) are filed herewith.
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has caused this report to be signed on its
behalf by the undersigned thereto duly authorized.
SIERRA HEALTH SERVICES, INC.
By: /S/ ANTHONY M. MARLON
Anthony M. Marlon
Date: March 28, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
/S/ ANTHONY M. MARLON, M.D. Chief Executive Officer March 28, 1997
Anthony M. Marlon, M.D. and Chairman of the Board
(Chief Executive Officer)
/S/ JAMES L. STARR Vice President of Finance March 28, 1997
James L. Starr Chief Financial Officer
and Treasurer
(Chief Accounting Officer)
/S/ ERIN E. MACDONALD President and March 28, 1997
Erin E. MacDonald Chief Operating Officer
Director
/S/ CHARLES L. RUTHE Director March 28, 1997
Charles L. Ruthe
/S/ WILLIAM J. RAGGIO Director March 28, 1997
William J. Raggio
/S/ THOMAS Y. HARTLEY Director March 28, 1997
Thomas Y. Hartley
59
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
CONDENSED BALANCE SHEETS - Parent Company Only
December 31,
1996 1995
CURRENT ASSETS:
Cash and Cash Equivalents .......................................... $ 17,761,000 $ 11,814,000
Short-term Investments.............................................. 12,055,000 26,196,000
Prepaid Expenses and Other Current Assets .......................... 8,103,000 2,144,000
Total Current Assets.......................................... 37,919,000 40,154,000
PROPERTY AND EQUIPMENT - NET ............................................ 32,596,000 26,828,000
EQUITY IN NET ASSETS OF SUBSIDIARIES .................................... 145,939,000 119,856,000
NOTES RECEIVABLE FROM SUBSIDIARIES ...................................... 9,804,000 12,593,000
LONG-TERM INVESTMENTS ................................................... 6,021,000 12,940,000
GOODWILL AND OTHER INTANGIBLE ASSETS .................................... 14,896,000 2,612,000
OTHER ................................................................... 10,330,000 6,850,000
TOTAL ASSETS ............................................................ $257,505,000 $221,833,000
CURRENT LIABILITIES:
Accounts Payable and Other Accrued Liabilities ..................... $ 13,268,000 $ 9,715,000
Current Portion of Long-term Debt .................................. 444,000 667,000
Total Current Liabilities .................................... 13,712,000 10,382,000
LONG-TERM DEBT(Less Current Portion)..................................... 3,241,000 3,736,000
OTHER LIABILITIES ....................................................... 6,070,000
TOTAL LIABILITIES ....................................................... 23,023,000 14,118,000
STOCKHOLDERS' EQUITY:
Capital Stock ...................................................... 89,000 88,000
Additional Paid-in Capital ......................................... 152,035,000 147,240,000
Treasury Stock ..................................................... (130,000) (130,000)
Unrealized Holding Gain on Available-for-sale Investments .......... 487,000 9,659,000
Retained Earnings .................................................. 82,001,000 50,858,000
Total Stockholders' Equity ................................... 234,482,000 207,715,000
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................... $257,505,000 $221,833,000
Note: Scheduled maturities of long-term debt, including the principal
portion of obligations under capital leases, are as follows:
Year Ending December 31,
1997................................................... $ 444,000
1998................................................... 429,000
1999................................................... 2,384,000
2000................................................... 428,000
2001................................................... --
Thereafter............................................. --
Total.............................................. $3,685,000
S-1
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
CONDENSED STATEMENT OF OPERATIONS -- Parent Company Only
Year Ended December 31,
1996 1995 1994
OPERATING REVENUES:
Management Fees........................................ $44,139,000 $40,115,000 $37,324,000
Subsidiary Dividends................................... 3,733,000 250,000 1,350,000
Investment and Other Income............................ 5,145,000 4,087,000 928,000
Total Operating Revenues............................ 53,017,000 44,452,000 39,602,000
GENERAL AND ADMINISTRATIVE EXPENSES:
Payroll and Benefits................................... 11,579,000 12,805,000 12,162,000
Depreciation........................................... 3,433,000 3,323,000 3,494,000
Rent................................................... 649,000 738,000 1,186,000
Repairs and Maintenance................................ 408,000 382,000 303,000
Legal.................................................. 1,874,000 226,000 1,109,000
Consulting............................................. 827,000 583,000 480,000
Other.................................................. 5,145,000 4,252,000 5,053,000
Acquisition, Restructuring and Other Expenses .......... 12,064,000 11,614,000
Total General and Administrative.................... 35,979,000 33,923,000 23,787,000
INTEREST EXPENSE AND OTHER, NET............................ (503,000) (396,000) (467,000)
EQUITY IN UNDISTRIBUTED
EARNINGS OF SUBSIDIARIES............................... 21,991,000 15,785,000 24,788,000
INCOME BEFORE INCOME TAXES................................. 38,526,000 25,918,000 40,136,000
PROVISION FOR INCOME TAXES................................. (7,383,000) (4,614,000) (5,693,000)
NET INCOME................................................. $31,143,000 $21,304,000 $34,443,000
S-2
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
CONDENSED STATEMENTS OF CASH FLOWS -- Parent Company Only
Year Ended December 31,
1996 1995 1994
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income........................................................... $31,143,000 $21,304,000 $34,443,000
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Depreciation and Amortization.................................... 3,611,000 3,449,000 3,533,000
Equity in Undistributed Earnings of Subsidiaries...................... (21,991,000) (15,787,000) (24,788,000)
Change in Assets and Liabilities:
Other Assets..................................................... (15,917,000) (5,021,000) 996,000
Current Assets................................................... (5,959,000) (504,000) (635,000)
Current Liabilities.............................................. 4,712,000 7,429,000 239,000
Other Long-term Liabilities ..................................... 6,069,000
Net Cash Provided by Operating Activities......................... 1,668,000 10,870,000 13,788,000
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures................................................. (9,292,000) (8,763,000) (1,935,000)
Decrease (Increase) in Short-term Securities.......................... 14,136,000 22,990,000 (45,316,000)
Decrease (Increase) in Other Assets.................................. 6,942,000 (8,963,000) (2,659,000)
Dividends from Subsidiary............................................ 3,733,000 250,000 1,350,000
Acquisitions, Net of Cash Acquired .................................. (31,270,000)
(Decrease) Increase in Net Assets in Subsidiaries..................... 14,321,000 (1,572,000) (7,189,000)
Net Cash Provided by (Used for) Investing Activities (1,430,000) 3,942,000 (55,749,000)
CASH FLOWS FROM FINANCING ACTIVITIES:
Loans to Subsidiaries ............................................... (12,593,000)
Reductions in Long-term Obligations and
Payments on Capital Leases....................................... (718,000) (789,000) (3,688,000)
Proceeds from Note Receivable to Subsidiary................................. 2,789,000
Proceeds from Issuance of Common Stock............................... 44,579,000
Exercise of Stock in Connection with Stock Plans..............................3,638,000 3,807,000 4,385,000
Net Cash (Used for) Provided by Financing Activities............. 5,709,000 (9,575,000) 45,276,000
Net increase in Cash and Cash Equivalents.................................. 5,947,000 5,237,000 3,315,000
Cash and Cash Equivalents at Beginning of Year.............................. 11,814,000 6,577,000 3,262,000
Cash and Cash Equivalents at End of Year................................... $17,761,000 $11,814,000 $ 6,577,000
Supplemental condensed statements of cash flows information:
Cash Paid During the Year for Interest
(Net of Amount Capitalized).......................................... $ 443,000 $ 455,000 $ 662,000
Cash Paid During the Year for Income Taxes................................. 6,423,000 2,746,000 2,592,000
Noncash Investing and Financing Activities:
Additions to Capital Leases.......................................... -- 278,000 552,000
Assumptions of Liability in Connection with
Land Purchase.................................................... -- 1,956,000 --
Stock Issued for Exercise of Options
and Related Tax Benefits......................................... 1,158,000 1,949,000 2,685,000
S-3
SIERRA HEALTH SERVICES, INC.
SUPPLEMENTAL INFORMATION
CONCERNING PROPERTY -- CASUALTY INSURANCE
(amounts in thousands)
Gross Claims & Claim Amortization
Reserves Adjustment of
Deferred for Unpaid Discount Expenses Incurred Deferred Paid Claims
Policy Claims and if any Gross Net Related to Policy and Claims Direct
Acquisition Adjustment Deducted in Unearned Earned Investment (1) (2) Acq. Adjustment Premiums
Affiliation With Costs Expenses Column C Premiums Premiums Income Current Prior Year Costs Expenses Written
Registrant Column A Column B Column C Column D Column E Column F Column G Year Column H Column I Column J Column K
Consolidated
Property and
Casualty Entities
of CII Financial,
Inc. for
Years Ended:
December 31, 1996 $1,832 $187,776 -- $9,885 $126,121 $16,422 $101,401 $(15,284) $21,968 $70,464 $126,497
December 31, 1995 1,928 182,318 -- 9,282 94,611 14,301 75,978 (20,079) 22,028 61,071 94,953
December 31, 1994 2,285 190,962 -- 8,940 94,684 12,506 67,642 (13,953) 23,238 66,584 92,983
S-4
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
SECTION 403.04b
RECONCILIATION OF BEGINNING AND ENDING LOSS AND LOSS
ADJUSTMENT EXPENSE RESERVES
AND EXHIBIT OF REDUNDANCIES (DEFICIENCIES)
(in thousands)
Year ended December 31
1996 1995 1994 1993 1992 1991 1990 1989 1988
Losses and LAE
Reserve...................... $187,776 $182,318 $190,962 $200,356 $178,460 $112,749 $ 67,593 $ 37,466 $ 10,277
Less Reinsurance
Recoverables (1)............. 15,676 25,871 29,342 25,841 20,207
Net Loss and LAE
Reserves .................... 172,100 156,447 161,620 174,515 158,253
Cumulative Net Paid
as of:
One Year Later .............. 45,731 44,519 50,210 50,360 57,611 39,118 14,820 3,954
Two Years Later ............. 68,619 79,788 84,465 89,177 65,165 28,657 6,609
Three Years Later 94,865 104,569 108,849 76,988 36,579 8,198
Four Years Later 114,293 120,539 83,822 39,345 8,938
Five Years Later 126,100 87,618 41,043 9,235
Six Years Later ............. 89,607 41,962 9,398
Seven Years Later 42,541 9,471
Eight Years Later 9,517
Net Reserve Re-estimated
as of:
One Year Later .............. 141,163 139,741 160,562 154,388 140,815 83,841 37,463 10,072
Two Years Later ............. 125,279 141,100 147,167 142,447 96,011 39,753 9,902
Three Years Later 126,483 134,747 143,433 97,142 43,528 9,598
Four Years Later 132,193 137,143 97,942 44,404 9,330
Five Years Later 135,249 94,852 45,027 10,042
Six Years Later ............. 93,561 44,543 10,110
Seven Years Later 43,741 10,124
Eight Years Later 9,695
Cumulative Redundancy
(Deficiency) ................ 15,284 36,341 48,032 26,060 (22,500) (25,968) (6,275) 582
Net Reserve..................... 172,100 156,447 161,620 174,515
Reinsurance Recoverables 15,676 25,871 29,342 25,841
Gross Reserve .................. 187,776 182,318 190,962 200,356
Net Re-estimated Reserve 141,164 125,279 126,483
Re-estimated Reinsurance
Recoverables ................ 17,428 17,682 13,987
Gross Re-Estimated
Reserve ..................... 158,592 142,961 140,470
Gross Cumulative
Redundancy................... $ 23,726 $ 48,001 $ 59,886
(1) The Company adopted Financial Accounting Standards Board Statement No.
113 ("FAS 113"), "Accounting and Reporting for Short-Duration and
Long-Duration Reinsurance Contracts" for the year ended December 31,
1992. As permitted, prior financial statements have not been restated.
Reinsurance recoverables on unpaid losses and LAE are shown as an asset
on the balance sheets at December 31, 1996 and 1995. However, for
purposes of the reconciliation and development tables, loss and LAE
information will be shown net of reinsurance.
(2) The above table includes the nine years of data since the commencement
of workers' compensation insurance operations by the Company.
See the notes to consolidated financial statements.
S-5