UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
X
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2000
------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________________ to _______________________
Commission File Number 1-8865
SIERRA HEALTH SERVICES, INC.
(Exact name of registrant as specified in its charter)
NEVADA 88-0200415
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2724 NORTH TENAYA WAY
LAS VEGAS, NV 89128
(Address of principal executive offices) (Zip Code)
(702) 242-7000
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
As of October 31, 2000, there were 27,292,000 shares
of common stock outstanding.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000
INDEX
<TABLE>
<CAPTION>
Page No.
Part I - FINANCIAL INFORMATION
Item l. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets -
<S> <C> <C> <C> <C> <C>
September 30, 2000 and December 31, 1999................ 3
Condensed Consolidated Statements of Operations -
three and nine months ended September 30, 2000 and 1999.... 4
Condensed Consolidated Statements of Cash Flows -
nine months ended September 30, 2000 and 1999.............5
Notes to Condensed Consolidated Financial Statements........6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............13
Item 3. Quantitative and Qualitative Disclosures
about Market Risk.........................................23
Part II - OTHER INFORMATION
Item l. Legal Proceedings...........................................24
Item 2. Changes in Securities and Use Of Proceeds...................24
Item 3. Defaults Upon Senior Securities.............................24
Item 4. Submission of Matters to a Vote of Security Holders.........24
Item 5. Other Information...........................................24
Item 6. Exhibits and Reports on Form 8-K............................24
Signatures....................................................................26
</TABLE>
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED
(Amounts in thousands)
<TABLE>
<CAPTION>
September 30 December 31
2000 1999
---- ----
ASSETS
CURRENT ASSETS:
<S> <C> <C>
Cash and Cash Equivalents.............................................. $ 54,747 $ 55,936
Investments............................................................ 195,291 218,951
Accounts Receivable (Less: Allowance for Doubtful
Accounts: 2000 - $21,750; 1999 - $15,551).................................... 35,543 43,036
Military Accounts Receivable (Less: Allowance for Doubtful
Accounts: 2000 - $1,109; 1999 - $800).............................. 97,017 60,340
Reinsurance Recoverable................................................ 90,910 54,563
Prepaid Expenses and Other Current Assets.............................. 88,646 91,767
Assets Held for Sale................................................... 22,942
------------
Total Current Assets............................................... 585,096 524,593
PROPERTY AND EQUIPMENT, NET................................................. 183,899 264,549
LONG-TERM INVESTMENTS....................................................... 20,175 14,862
RESTRICTED CASH AND INVESTMENTS............................................. 23,977 21,705
REINSURANCE RECOVERABLE, Net of Current Portion............................. 119,895 82,300
GOODWILL ................................................................... 15,594 159,514
OTHER ASSETS................................................................ 113,942 62,589
------------ -------------
TOTAL ASSETS................................................................ $1,062,578 $1,130,112
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts Payable and Accrued Liabilities.................................. $ 99,103 $ 102,573
Medical Claims Payable.................................................... 111,106 91,607
Current Portion of Reserve for Losses and Loss Adjustment Expense ........ 139,038 93,768
Unearned Premium Revenue.................................................. 21,745 45,333
Military Health Care Payable.............................................. 75,949 50,831
Payable Under Revolving Credit Facility................................... 185,000
Premium Deficiency Reserve................................................ 21,094 21,000
Current Portion of Long-term Debt......................................... 85,228 4,741
------------- --------------
Total Current Liabilities............................................ 738,263 409,853
RESERVE FOR LOSSES AND LOSS ADJUSTMENT EXPENSE.............................. 196,865 150,626
LONG-TERM DEBT.............................................................. 11,330 258,854
OTHER LIABILITIES .......................................................... 33,857 32,367
------------- -------------
TOTAL LIABILITIES........................................................... 980,315 851,700
------------ ------------
STOCKHOLDERS' EQUITY:
Preferred Stock, $.01 Par Value, 1,000
Shares Authorized; None Issued or Outstanding
Common Stock, $.005 Par Value, 40,000 Shares Authorized;
Shares Issued: 2000 - 28,815; 1999 - 28,400......................... 144 142
Additional Paid-in Capital................................................ 177,495 175,915
Treasury Stock, 2000 - 1,523; 1999 - 1,523 Common Shares.................. (22,789) (22,789)
Accumulated Other Comprehensive Loss:
Unrealized Holding Loss on Available-for-Sale Investments............ (11,292) (16,063)
Accumulated (Deficit) Retained Earnings................................... (61,295) 141,207
-------------- ------------
Total Stockholders' Equity........................................... 82,263 278,412
------------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................. $1,062,578 $1,130,112
========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements
<PAGE>
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
UNAUDITED
(Amounts in thousands except for per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------ ------------
2000 1999 2000 1999
---- ---- ---- ----
OPERATING REVENUES:
<S> <C> <C> <C> <C>
Medical Premiums.................................... $221,669 $202,643 $660,098 $614,603
Military Contract Revenues.......................... 101,259 77,012 238,514 218,193
Specialty Product Revenues.......................... 40,766 24,589 98,880 66,217
Professional Fees................................... 8,222 12,743 28,938 40,112
Investment and Other Revenues....................... 5,566 5,583 15,282 17,337
----------- ---------- --------- ---------
Total ............................................ 377,482 322,570 1,041,712 956,462
--------- -------- --------- --------
OPERATING EXPENSES:
Medical Expenses (Note 2) .......................... 191,566 173,787 630,873 539,094
Military Contract Expenses.......................... 99,889 74,139 232,872 210,243
Specialty Product Expenses.......................... 41,671 22,962 115,403 61,833
General, Administrative and Marketing
Expenses.......................................... 34,327 34,246 103,312 102,789
Asset Impairment, Restructuring, Reorganization
and Other Costs (Note 2).......................... 220,440 5,106
--------------- --------------- ------- ----------
Total ............................................ 367,453 305,134 1,302,900 919,065
--------- --------- --------- --------
OPERATING INCOME (LOSS)............................... 10,029 17,436 (261,188) 37,397
INTEREST EXPENSE AND OTHER, NET ..................... (6,091) (4,169) (16,828) (12,344)
------ --------- ------- ----------
INCOME (LOSS) BEFORE INCOME TAXES .................... 3,938 13,267 (278,016) 25,053
(PROVISION) BENEFIT FOR INCOME TAXES.................. (1,269) (4,404) 75,524 (8,340)
------- -------- ------ ----------
NET INCOME (LOSS) .................................... $ 2,669 $ 8,863 $ (202,492) $ 16,713
========= ======== ========== ========
NET INCOME (LOSS) PER COMMON SHARE.................... $ .10 $.33 $(7.47) $.62
===== ==== ====== ====
NET INCOME (LOSS) PER COMMON SHARE
ASSUMING DILUTION .................................. $ .10 $.33 $(7.47) $.62
===== ==== ====== ====
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING .................................. 27,248 26,856 27,092 26,944
======== ======= ======== ========
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING ASSUMING DILUTION....................... 27,250 26,873 27,092 26,976
======== ======== ======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
<PAGE>
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
UNAUDITED
(Amounts in thousands)
<TABLE>
<CAPTION>
Nine Months Ended September 30
2000 1999
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net (Loss) Income ........................................................... $(202,492) $ 16,713
Adjustments to Reconcile Net (Loss) Income to Net Cash
Used for Operating Activities:
Provision for Asset Impairment and Other Charges...................... 202,951 3,509
Depreciation and Amortization......................................... 23,588 20,946
Provision for Doubtful Accounts....................................... 3,032 4,290
Changes in Assets and Liabilities ........................................... (57,628) (88,787)
------- --------
Net Cash Used for Operating Activities .................................. (30,549) (43,329)
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures, Net of Equipment Dispositions.......................... (13,615) (41,072)
Investment Proceeds, Net of Purchases........................................ 23,439 8,224
Corporate Acquisition........................................................ (3,000)
------------ ---------
Net Cash Provided by (Used for) Investing Activities......................... 9,824 (35,848)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Borrowings..................................................... 48,000 79,000
Payments on Debt and Capital Leases.......................................... (30,036) (41,250)
Purchase of Treasury Stock................................................... (7,968)
Exercise of Stock in Connection with Stock Plans............................. 1,572 2,332
-------- ----------
Net Cash Provided by Financing Activities............................. 19,536 32,114
------- ----------
NET DECREASE IN CASH AND CASH EQUIVALENTS....................................... (1,189) (47,063)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD................................ 55,936 83,910
-------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD...................................... $ 54,747 $ 36,847
========= ========
Nine Months Ended September 30
Supplemental Condensed Consolidated
Statements of Cash Flows Information: 2000 1999
------------------------------------------------------------------------ ---- ----
Cash Paid During the Period for Interest
(Net of Amount Capitalized).................................................. $19,511 $14,077
Net Cash Received During the Period for Income Tax Refunds...................... 10,538 3,029
Non-cash Investing and Financing Activities:
Note Received for Sale of Investment......................................... 3,700
Tax Benefits of Stock Issued for Exercise of Options......................... 1
</TABLE>
See accompanying notes to condensed consolidated financial statements
<PAGE>
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. The accompanying unaudited financial statements include the consolidated
accounts of Sierra Health Services, Inc. ("Sierra", a holding company, together
with its subsidiaries, collectively referred to herein as the "Company"). All
material intercompany balances and transactions have been eliminated. These
statements have been prepared in conformity with accounting principles generally
accepted in the United States of America and used in preparing the Company's
annual audited consolidated financial statements but do not contain all of the
information and disclosures that would be required in a complete set of audited
financial statements. They should, therefore, be read in conjunction with the
Company's annual audited consolidated financial statements and related notes
thereto for the years ended December 31, 1999 and 1998. In the opinion of
management, the accompanying unaudited condensed consolidated financial
statements reflect all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the financial results for the
interim periods presented.
2. Premium Deficiency, Adverse Development, Reorganization, Impairment and
Other Charges: Medical Expenses: Medical expenses reported in the second quarter
of 2000 included $29.5 million of reserve strengthening primarily due to adverse
development on prior periods' medical claims, as well as $15.5 million in
premium deficiency expense related to under-performing markets in the Dallas/Ft.
Worth and Houston areas. The recorded premium deficiency reflects anticipated
cost savings from restructuring and reorganization actions discussed below. In
addition, the Company recorded $10.2 million of other non-recurring medical
costs primarily relating to the write-down of medical subsidiary assets. Medical
expenses reported in the first quarter of 2000 included $1 million of prior
period reserve strengthening.
Medical expenses reported in the first quarter of 1999 included a premium
deficiency charge of $8.1 million related to losses in under-performing
markets, primarily in Arizona and rural Nevada.
Asset Impairment, Restructuring, Reorganization and Other Charges: Asset
impairment, restructuring, reorganization and other charges recorded in the
second quarter of 2000 consisted of the following:
<TABLE>
<S> <C>
Goodwill Impairment......................................... $141,506,000
Fixed Asset Impairment...................................... 48,984,000
Restructuring............................................... 10,592,000
Premium Deficiency Maintenance Costs........................ 10,358,000
Other Costs................................................. 6,100,000
--------------
Total .......................................... $217,540,000
============
</TABLE>
Goodwill and Fixed Asset Impairments: In connection with restructuring
plans adopted and announced by the Company in the second quarter of 2000, the
Company re-evaluated the recoverability of certain long-lived assets, primarily
associated with the Texas operations, in accordance with Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" ("SFAS No. 121") and
Accounting Principles Board Opinion No. 17, "Intangible Assets" ("APB No. 17")
and determined that the carrying values of certain goodwill and other long-lived
assets were impaired.
Based on financial projections for 2000, the Company recorded a $21.0
million premium deficiency at the end of 1999, relative to the Company's
Texas operations. In the first quarter of 2000, the
<PAGE>
SIERRA HEALTH SERVICES, INC., AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
Company engaged a consultant to help it assess the Texas operations. In
late February, the consultant issued its report and the Company implemented
strategic action plans to turn around the Texas operations. These actions
included the replacement of the Texas senior management, a reduction in
staffing along with a consolidation of certain services to Las Vegas and a
revision of product strategy.
The new management was charged with further assessing the Dallas/Ft. Worth
health care delivery system. In May, the Company decided that the delivery
system, which emphasized an affiliated medical group as the primary
provider network, would be replaced by an expanded network of contracted
physician groups and individual practitioners. In addition, the contracted
hospital network would be significantly expanded. As a result, during the
second quarter of 2000, the Company adopted and announced a further
restructuring of the Dallas/Ft. Worth operations, which entailed a
significant reduction of physicians and staff and the closing of several
clinic sites. In addition, management decided that the real estate assets
would be sold.
Management also adopted a plan in the second quarter of 2000 to discontinue
medical delivery operations in Mohave County, Arizona and to sell the real
estate assets located there, as well as an underperforming medical clinic
in Las Vegas.
In assessing the asset impairment of the long-lived assets, the Company
first allocated a portion of related goodwill to the fixed assets to be
disposed of, in accordance with SFAS No. 121. The fixed assets were then
written down to estimated fair value less costs to sell, which was
determined from independent evaluations. The remainder of the related
goodwill was then assessed for recoverability in accordance with APB No. 17
based on projected discounted cash flows.
Restructuring: In the second quarter of 2000, the Company adopted a plan
and announced additional restructuring of its managed health care
operations, primarily in Texas and Arizona. As a result of this
restructuring, the Company recorded charges in accordance with Emerging
Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity
(Including Certain Costs Incurred in a Restructuring)" of approximately
$10.6 million. A re-evaluation of these costs during the third quarter of
2000 resulted in no adjustments. Of the costs recorded, $5.9 million was
for severance, $2.9 million was related to clinic closures and lease
terminations, and $1.8 million was for other costs. The severance charge
resulted from the termination of 315 employees at the Company's
subsidiaries and affiliated medical groups. Of these amounts, the Company
anticipates paying $8.7 million during 2000 and the remainder in 2001.
Through the year to date period ended September 30, 2000, approximately
$7.2 million was paid of which $4.9 million was for severance.
In the first quarter of 2000, the Company announced a restructuring of its
managed health care operations in Texas. As a result of this restructuring,
the Company incurred approximately $1.4 million of severance pay for
employees who were terminated, of which approximately $1.3 million was paid
in the second quarter of 2000 and the remainder in the third quarter of
2000. The restructuring involved changes in senior management at the Texas
facilities and centralization of key services to Las Vegas. As compared to
the quarter ended June 30, 2000, management anticipates the restructuring
and reorganization activities to result in cash flow savings of
approximately $2.0 to $3.0 million per quarter beginning in the fourth
quarter of 2000.
Premium Deficiency Maintenance Costs: The premium deficiency maintenance
costs recorded in the second quarter of 2000 are an estimate of general and
administrative costs, in excess of those covered by premiums, the Company
will incur to service the Texas contracts. The amount reflects anticipated
cost reductions from the restructuring actions noted above. Of this amount,
the company expects to utilize $7.3 million in 2000 and $3.1 million in
2001.
<PAGE>
Other Costs: The remaining $6.1 million of costs recorded in the second
quarter of 2000 relate primarily to the write-down of certain receivables
as well as an accrual for litigation expense.
In the first quarter of 2000, the Company incurred $1.5 million of costs,
consisting primarily of consulting fees, in conjunction with a review and
reorganization of its managed care operations in Texas.
In March 1999, the Company closed all inpatient operations at Mohave Valley
Hospital, a 12-bed acute care facility in Bullhead City, Arizona and
terminated approximately 45 employees. The Company recorded a charge of
$4.3 million related primarily to the write-off of goodwill associated with
the Mohave Valley operations.
In the first quarter of 1999, the Company also incurred $450,000 for
certain legal and contractual settlements and $400,000 to provide for the
Company's portion of the write-off of start-up costs at the Company's
equity investee, TriWest Healthcare Alliance. In accordance with Statement
of Position 98-5, TriWest expensed all remaining start-up costs in their
fiscal year beginning April 1, 1999.
3. During the first quarter of 2000, the Company sold its interest in TriWest
Healthcare Alliance. The Company received a note for $3.7 million, which
approximated the carrying value of this investment. The note is included in
Other Current Receivables and is payable in six monthly installments
beginning at the end of October 2000.
4. The assets designated as held for sale on the balance sheet at September
30, 2000 consist of real estate for which the Company is actively seeking a
buyer and expects to sell within twelve months. All assets are owned by
subsidiaries in the managed care and corporate operations segment. See Note 2
for a description of the primary facts and circumstances leading to the decision
to sell this real estate. A related mortgage note in the amount of $34.5 million
is included in the current portion of long-term debt on the balance sheet.
Because these assets have been written down to fair market value, in accordance
with SFAS No. 121, the Company has ceased depreciating them. In addition, the
Company has announced that it is pursuing a sale and leaseback of certain Las
Vegas properties that are included in the property and equipment line on the
balance sheet.
5. As of June 30, 2000, the Company was not in compliance with certain
financial covenants relating to its line of credit. The borrowed amount
outstanding on the line of credit as of September 30, 2000 was $185 million.
Under the terms of its line of credit, noncompliance with the covenants
constitutes an event of default, which permits the Company's lenders to
accelerate repayment of the Company's outstanding obligations under its line of
credit. The lenders waived the Company's compliance with these covenants under
its line of credit. The waiver was effective as of June 30, 2000 and, as
extended, expired on October 31, 2000. The Company was unable to reach terms
with the lenders on the fees and length of a new waiver and received a Notice of
Default on November 8, 2000 from its lenders with respect to the Company's
non-compliance with the financial covenants. The Company is working with its
lenders to amend the line of credit agreement and expects to have negotiated a
new amendment with revised covenants prior to year end. In accordance with
Statement of Financial Accounting Standards No. 78, "Classification of
Obligations that are Callable by the Creditor", the Company has classified the
entire outstanding balance under its line of credit as a current liability as of
September 30, 2000.
The waivers included amendments (fourth through sixth) to the line of
credit, which, among other things, required that the Company grant its
lenders a security interest in certain personal property of the Company,
reduced the availability under the line of credit to $185 million,
increased the Company's borrowing rate by 287.5 basis points with interest
to be paid monthly and provided for the payment of additional fees by the
Company. In addition, the fourth amendment provided for a guaranty of the
debt by the majority of the Company's wholly-owned subsidiaries, including
CII Financial, Inc., but excluding
Sierra Military Health Services, and for the pledge of common stock of a
majority of the Company's wholly-owned subsidiaries, excluding CII
Financial, Inc., and its subsidiaries. With the expiration of the waiver
on October 31, 2000, the
Company is continuing to pay interest at the default rate of LIBOR plus
5.25%. There can be no assurances that a new amendment with revised
covenants will be obtained.
6. CII Financial, Inc., a wholly-owned subsidiary that the Company acquired
in 1995, has $47.0 million of convertible subordinated debentures (the
"Debentures") due September 15, 2001 and bearing interest at 7 1/2%, which is
due semi-annually on March 15 and September 15. As of September 30, 2000, all
$47.0 million of the Debentures are classified as current since they are due
September 15, 2001. Each $1,000 in principal is convertible into 25.382 shares
of the Company's common stock at a conversion price of $39.40 per share. The
Debentures are general unsecured obligations of CII Financial and are not
guaranteed by the Company. In August 2000, CII Financial became a guarantor of
the debt owed under the Company's line of credit. In the event of a demand to
perform on the guaranty, the Debentures would be subordinated to the debt owed
under the line of credit. During the nine months ended September 30, 2000, CII
Financial purchased $3.5 million of the Debentures on the open market.
CII Financial has limited sources for its cash and had to borrow
approximately $365,000 from the Company to make the September 15, 2000
interest payment. Absent any funding from the Company, CII Financial would
be dependent upon dividends from its
subsidiary, California Indemnity Insurance Company ("California Indemnity")
to meet its debt payment obligations. Currently, California Indemnity
cannot pay any dividends without prior approval by the California
Department of Insurance as it has no earned surplus and it is unlikely that
it will have sufficient earned surplus from which to pay a dividend to CII
Financial when the Debentures mature in 2001. It is also unlikely that the
Company will be in a position to lend any or enough funds to CII Financial
to pay the Debentures when they mature due to the current limitations of
the line of credit facility. Accordingly, CII Financial will not have
readily available funds to pay the Debentures when they mature. CII
Financial and the Company are investigating strategies to resolve this
issue. Such strategies include, but are not limited to, refinancing the
Debentures, extending the maturity date, exchanging the Debentures at a
discount for cash and/or equity or spinning off the subsidiary.
There can be no assurances that CII Financial or
the Company can successfully implement a strategy for the repayment or
refinancing of the Debentures.
7. The following table provides a reconciliation of basic and diluted
earnings per share ("EPS"):
<TABLE>
<CAPTION>
Dilutive
Basic Stock Options Diluted
For the Three Months ended September 30, 2000:
<S> <C> <C>
Income from Continuing Operations $ 2,669,000 $ 2,669,000
Shares 27,248,000 2,000 27,250,000
Per Share Amount $.10 $.10
For the Three Months ended September 30, 1999:
Income from Continuing Operations $ 8,863,000 $ 8,863,000
Shares 26,856,000 17,000 26,873,000
Per Share Amount $.33 $.33
For the Nine Months ended September 30, 2000:
Loss from Continuing Operations $(202,492,000) $(202,492,000)
Shares 27,092,000 27,092,000
Per Share Amount $(7.47) $(7.47)
For the Nine Months ended September 30, 1999:
Income from Continuing Operations $ 16,713,000 $ 16,713,000
Shares 26,944,000 32,000 26,976,000
Per Share Amount $.62 $.62
</TABLE>
CII Financial, Inc., a wholly-owned subsidiary of the Company,
has outstanding convertible subordinated debentures (the "Debentures")
due September 15, 2001. Each $1,000 in principal is convertible
into 25.382 shares of the Company's common stock at a conversion
price of $39.40 per
share. The Debentures were not included in the computation of EPS because
their effect would be anti-dilutive.
8. The following table presents comprehensive income (loss) for the
three-month and nine-month periods ended September 30, 2000 and 1999:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
NET INCOME (LOSS):............................... $ 2,669,000 $8,863,000 $(202,492,000) $ 16,713,000
Change in net Unrealized Holding Gains
(Losses) on Investments,
net of income taxes................ 921,000 (3,172,000) 4,771,000 (12,735,000)
---------- ------------ ------------ -----------
COMPREHENSIVE INCOME (LOSS) .................... $3,590,000 $5,691,000 $(197,721,000) $3,978,000
========= ========== =========== =========
</TABLE>
9. Segment Reporting:
The Company has three reportable segments based on the products and
services offered: managed care and corporate operations, military health
services operations and workers' compensation operations. The managed care
segment includes managed health care services provided through HMOs,
managed indemnity plans, third-party administrative services programs for
employer-funded health benefit plans, multi-specialty medical groups, other
ancillary services and corporate operations. The military health services
segment administers a managed care federal contract for the Department of
Defense's TRICARE program in Region 1. This contract is structured as five
one-year option periods and is currently in its third year. The workers'
compensation segment insures workers' compensation claims risk in return
for premium revenues.
Sierra evaluates each segment's performance based on segment operating
profit before interest expense and income taxes and excludes charges that
obscure current period operating results, and unusual and non-recurring
charges, such as: prior period development in medical and loss reserves,
premium deficiencies, asset impairment, restructuring and other
non-recurring gains and losses. Other than excluding such charges, the
accounting policies of the operating segments are the same as those of the
consolidated company.
<PAGE>
Information concerning the operations of the reportable segments is as follows:
(Amounts in thousands)
<TABLE>
<CAPTION>
Managed Care Military Workers'
and Corporate Health Services Compensation
Operations Operations Operations Total
Three Months Ended September 30, 2000
<S> <C> <C>
Medical Premiums............................. $ 221,669 0 $ 221,669
Military Contract Revenues................... $ 101,259 101,259
Specialty Product Revenues................... 2,166 $ 38,600 40,766
Professional Fees............................ 8,222 8,222
Investment and Other Revenues................ 1,584 147 3,835 5,566
----------- ---------- --------- ----------
Total Revenue............................. $ 233,641 $ 101,406 $ 42,435 $ 377,482
Segment Operating Profit..................... $ 6,182 $ 1,518 $ 2,329 $ 10,029
Interest Expense and Other, Net.............. (5,311) (74) (706) (6,091)
Net Income Before Income Taxes............... $ 871 $ 1,444 $ 1,623 $ 3,938
=========== ========== ======= =========
Three Months Ended September 30, 1999
Medical Premiums............................. $ 202,643 $ 202,643
Military Contract Revenues................... $ 77,012 77,012
Specialty Product Revenues................... 2,395 $ 22,194 24,589
Professional Fees............................ 12,743 12,743
Investment and Other Revenues................ 1,625 161 3,797 5,583
---------- ---------- -------- ------------
Total Revenue............................. $ 219,406 $ 77,173 $ 25,991 $ 322,570
Segment Operating Profit..................... $ 9,295 $ 3,039 $ 5,102 $ 17,436
Interest Expense and Other, Net.............. (3,105) (132) (932) (4,169)
--------- ----------- -------- ------------
Net Income Before Income Taxes............... $ 6,190 $ 2,907 $ 4,170 $ 13,267
========== ========== ======== ==========
Nine Months Ended September 30, 2000
Medical Premiums............................. $ 660,098 $ 660,098
Military Contract Revenues................... $ 238,514 238,514
Specialty Product Revenues................... 6,858 $ 92,022 98,880
Professional Fees............................ 28,938 28,938
Investment and Other Revenues................ 3,880 601 10,801 15,282
----------- ----------- ------- --------
Total Revenue............................. $ 699,774 $ 239,115 $ 102,823 $1,041,712
Segment Operating Profit..................... $ 16,981 $ 6,245 $ 8,823 $ 32,049
Interest Expense and Other, Net.............. (14,713) (439) (1,676) (16,828)
Impairment, Restructuring, Premium Deficiency
and Other Charges......................... (273,737) _______ (19,500) (293,237)
--------- ------- --------
Net (Loss) Income Before Income Taxes........ $ (271,469) $ 5,806 $(12,353) $ (278,016)
======== ========= ======= ========
Nine Months Ended September 30, 1999
Medical Premiums............................. $ 614,603 $614,603
Military Contract Revenues................... $ 218,193 218,193
Specialty Product Revenues................... 6,951 $ 59,266 66,217
Professional Fees............................ 40,112 40,112
Investment and Other Revenues................ 5,006 410 11,921 17,337
-------- ----------- ---------- ---------
Total Revenue............................. $ 666,672 $ 218,603 $ 71,187 $ 956,462
Segment Operating Profit..................... $ 27,177 $ 8,359 $ 15,067 $ 50,603
Interest Expense and Other, Net.............. (8,921) (682) (2,741) (12,344)
Impairment, Restructuring, Premium Deficiency
and Other Charges......................... (13,206) (13,206)
--------- -------------- -------------- --------
Net Income Before Income Taxes............... $ 5,050 $ 7,677 $ 12,326 $ 25,053
========== ========== ========== =========
</TABLE>
10. In the second quarter of 1997, the Company's Board of Directors authorized
a $3.0 million line of credit from the Company to the Company's Chief
Executive Officer ("CEO"). In April 2000, the Company's Board of Directors
authorized a $2.5 million loan from the Company to the CEO which, along
with accrued interest, is due on June 30, 2002. As of September 30, 2000,
the aggregate principal outstanding and accrued interest for both
instruments was $5.3 million. All borrowed amounts bear interest at a rate
equal to the rate at which the Company could have borrowed funds under its
line of credit facility at the time of the borrowing plus 10 basis points.
11. In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 clarifies existing accounting principles related to revenue
recognition in financial statements. The Company is required to comply with the
provisions of SAB 101 by the fourth quarter of 2000. Management has not yet
completed an analysis of the impact that SAB 101 will have on the Company's
current revenue recognition practices. In June 1998, the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities." In June 2000, the FASB issued SFAS No. 138, which amends certain
provisions of SFAS 133 to clarify areas causing difficulties in implementation.
The Company will adopt SFAS 133, as amended by SFAS 138, on January 1, 2001.
SFAS 133, as amended, is not expected to have a material impact on the
Company's consolidated financial position, results of operations or cash flows.
12. Certain amounts in the Condensed Consolidated Financial Statements for the
three and nine months ended September 30, 1999 have been reclassified to
conform with the current year presentation.
<PAGE>
SIERRA HEALTH SERVICES, INC., AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis provides information that management
believes is relevant for an 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 Quarterly Report on Form 10-Q
should be considered in connection with certain cautionary statements contained
in the Company's Current Report on Form 8-K dated March 15, 2000, incorporated
herein by reference. Such cautionary statements are made pursuant to the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995 and
identify important risk factors that could cause the Company's actual results to
differ from those expressed in any projected, estimated or forward-looking
statements relating to the Company.
Results of Operations, Three Months Ended September 30, 2000, Compared to Three
Months Ended September 30, 1999.
The Company's total operating revenues for the three months ended September 30,
2000, increased approximately 17.0% to $377.5 million from $322.6 million for
the three months ended September 30, 1999. The change was primarily due to
increases in military revenues of $24.2 million, medical premium revenues of
$19.0 million and specialty product revenues of $16.2 million, offset by a
decrease in professional fees of $4.5 million.
Total member months (the number of months of each period that an individual is
enrolled in a plan) for the HMO and insurance subsidiaries decreased
approximately 4%. Commercial and Medicaid HMO member months in total decreased
approximately 4% and managed indemnity member months decreased approximately
10%. These decreases were partially offset by an increase in Medicare member
months of approximately 7%. In Nevada, commercial and Medicaid HMO member months
increased approximately 2% and Medicare member months increased approximately
3%. In Texas, commercial member months decreased approximately 8%, while
Medicare member months increased 28% primarily due to growth in the Dallas/Ft.
Worth area. Such growth in Medicare member months contributes significantly to
the increase in premium revenues as the Medicare per member premium rates are
over three times higher than the average commercial premium rate.
The Company's HMO and insurance subsidiaries' average premium rate per member
increased approximately 14% for the three months ended September 30, 2000
compared to the same three-month period in 1999. The Nevada commercial and
Medicaid HMO average premium rate per member increased approximately 5% and the
Nevada area Medicare HMO average premium rate per member increased approximately
8%. The increase in the Nevada area Medicare HMO rates is primarily due to the
Company's exit from the Arizona Medicare program effective January 1, 2000. The
amount of premium received from the Health Care Financing Administration
("HCFA") per Medicare member is higher in Las Vegas than in the Company's
Arizona market. HCFA's established rate per member increased 4% for the Las
Vegas area. Over 97% of the Company's Las Vegas Medicare members are enrolled in
the HCFA Social HMO Medicare Program ("Social HMO"). The Company's premium
received from HCFA is higher for Social HMO members. HCFA might adjust the
reimbursement factor for the Social HMO members in the future. If the
reimbursement for these members decreases significantly and related benefit
changes are not made timely, there could be a material adverse effect on the
Company's business. Managed indemnity premium rates per member increased
approximately 18%.
<PAGE>
SIERRA HEALTH SERVICES, INC., AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
Results of Operations, Three Months Ended September 30, 2000, Compared to
Three Months Ended September 30, 1999 (continued)
The Texas commercial HMO average premium rate per member increased approximately
28% in the quarter ended September 30, 2000 compared to the same quarter in
1999. Commercial rate increases on renewals were greater than 10% for Dallas.
The Texas Medicare average rate decreased less than 1% primarily due to an
increase in Medicare membership in Dallas and certain counties in Houston, which
has a lower rate than most of the Company's Medicare members in the Beaumont
area outside of Houston.
As part of the Company's reorganization, it will no longer actively market its
HMO Medicare product in Texas for the remainder of calendar year 2000. The
Company will continue to enroll Medicare eligible members who proactively seek
coverage in Texas and will continue customer service to its existing membership
through 2000. The Company has notified HCFA that effective January 1, 2001 it
will cease its Medicare products in 14 counties in the Houston area, which will
affect approximately 1500 members.
The Company markets its HMO and managed indemnity insurance products primarily
to employer groups, labor unions and individuals enrolled in Medicare, through
its internal sales personnel and independent insurance brokers. Such brokers
receive commissions based on the premiums received from each group. The
Company's agreements with its member groups are usually for twelve months and
are subject to annual renewal. For the quarter ended September 30, 2000, the
Company's ten largest commercial HMO employer groups were, in the aggregate,
responsible for less than 10% of its total revenues. Although none of such
employer groups accounted for more than 2% of total revenues for that period,
the loss of one or more of the larger employer groups could, if not replaced
with similar membership, have a material adverse effect on the Company's
business.
Military contract revenue increased to $101.3 million from $77.0 million. The
31% increase is primarily attributable to accrued bid price adjustment revenue
which resulted from a true-up of prior periods' information received from the
government and is largely offset by accrued military contract expenses.
Specialty product revenue increased $16.2 million, or 66%, for the three months
ended September 30, 2000, compared to the same prior year period. Specialty
product revenues and expenses are primarily related to the workers' compensation
insurance business. The increase in specialty product revenues related to the
workers' compensation insurance segment was primarily due to premium growth,
which has occurred since July 1999, and premium rate increases for California
policies issued in 2000, which have averaged over 30% on renewal policies, as
well as new business in Nevada and Colorado. Beginning in July 1999, the State
of Nevada allowed private insurance companies to offer workers' compensation
products. In addition, premiums ceded under the low-level reinsurance agreement
are decreasing as it is in run-off starting July 1, 2000.
Professional fees decreased approximately $4.5 million or 35% primarily due to
the sale of the pharmacy operations in Texas in the fourth quarter of 1999 and
staffing reductions in the Company's affiliated Texas and Arizona medical
groups.
Investment and other revenues was down slightly by $17,000 over the comparable
prior year period primarily due to a decrease in invested balances. Net realized
losses included in investment and other revenues for the three months ended
September 30, 2000 were $105,000 compared to net realized losses of $229,000 in
the comparable prior year period.
Total medical expenses increased $17.8 million over the same three-month period
last year. Medical expenses as a percentage of medical premiums and professional
fees ("Medical Care Ratio") increased by 260 basis points to 83.3% for the
quarter ended September 30, 2000 compared to the same prior year period. The
increase in the Medical Care Ratio is primarily due to the increase in Medicare
members as a percentage of fully insured members. The cost of providing medical
care to Medicare members generally requires a greater percentage of the premiums
received. In Houston, hospital costs were higher due to increased hospital
rates.
Included in medical expenses is the utilization of $1.6 million of premium
deficiency reserve to offset losses on contracts in Texas for the three months
ended September 30, 2000 compared to a utilization of $13.0 million in the same
prior year period. Also included in medical expenses for the three months ended
September 30, 1999 is the utilization of $1.4 million of premium deficiency
reserve to offset losses primarily on Medicare risk members in Arizona and rural
Nevada.
Total military contract expenses for the three-month period ended September 30,
2000 increased by $25.8 million to $99.9 million compared to the prior year
period. The increase was primarily due to the costs associated with the accrued
bid price adjustment revenues.
Specialty product expenses increased $18.7 million. The combined ratio for the
workers' compensation insurance business for the three months ended September
30, 2000 was 104.5% compared to 94.5% for the comparable prior year period. The
increase was due to an increase in the loss and loss adjustment expense ("LAE")
ratio to 79.2% from 61.0% in 1999, partially offset by a decrease in the expense
ratio to 23.3% from 33.5% in 1999. The remaining variance is due to
policyholders' dividends incurred for participating policies issued in the State
of Nevada. The policyholders' dividend ratio in 2000 was 2.0% while no dividends
were incurred in 1999.
The higher loss and LAE ratio for the three months ended September 30, 2000 is
due primarily to the initial run-off of the low-level reinsurance agreement,
which expired on June 30, 2000, and to establishing a higher loss ratio on the
current accident year compared to the prior year period. In accordance with the
terms of the low-level reinsurance agreement, the Company elected to continue
coverage on a run-off basis for all policies in force on June 30, 2000. On July
1, 2000, the Company entered into a reinsurance agreement that covers losses on
claims in excess of $250,000 per occurrence for policies issued after June 30,
2000. The higher loss ratio for the current accident year was in response to the
significant adverse development experienced by the Company in the second quarter
of 2000 when additional reserves of $19.2 million were recorded. The Company did
not record any prior year loss development in either the current quarter or the
comparable prior year period.
The reduction in the expense ratio is primarily due to the higher premium volume
earned in 2000 compared to 1999. For the quarter ended September 30, 2000, net
premiums earned were $38.3 million or 75% higher than the $21.9 million in the
comparable prior year quarter. As a percentage of net earned premiums, policy
acquisition costs, which are comprised of commissions, premium taxes and boards
and bureaus expenses, increased to 10.8% from 10.1% in 1999 due to a lower
credit percentage for low-level ceding commissions. Total non-policy acquisition
expenses were $4.8 million compared to $5.1 million in 1999, a decrease of 6%
and as a percentage of net earned premiums were 12.5% compared to 23.4% for the
prior year period. Gross premiums earned for the quarter increased from $38.8
million in 1999 to $57.2 million in 2000, an increase of 47%.
General, administrative and marketing ("G&A") costs increased slightly to $34.3
million compared to the third quarter of 1999. As a percentage of total
revenues, G&A costs for the third quarter of 2000 decreased to 9.1% from 10.6%
in 1999 due primarily to the higher revenues in the period. As a percentage of
medical premium revenues, G&A costs represent 15.5% and 16.9% for the third
quarter 2000 and 1999, respectively. Excluding the utilization of premium
deficiency reserves of $.4 million in the third quarter of 2000 compared to $8.5
million in the same prior year period, G&A costs for the third quarter of 2000
are lower by $8.0 million due to lower Texas costs as well as a $1.1 million
decrease in depreciation and amortization expense, primarily related to the
write-down of goodwill and other impaired assets in the second quarter of 2000.
Interest expense and other increased $1.9 million for the three months ended
September 30, 2000, compared to the same prior year period primarily due to an
increase in debt as well as an increase in the Company's cost of borrowing.
For the current year period, the Company recorded $1.3 million of tax expense
for an effective tax rate of 32.3% compared to 33.2% for the same prior year
period. The Company's effective tax rate is less than the 35% statutory rate
primarily due to tax preferred investments.
Results of Operations, Nine Months Ended September 30, 2000, Compared to Nine
Months Ended September 30, 1999.
The Company's total operating revenues for the nine months ended September 30,
2000, increased approximately 8.9% to $1,041.7 million from $956.5 million for
the nine months ended September 30, 1999. The increase was primarily due to
increases in medical premium revenues of $45.5 million or 7%, military revenues
of $20.3 million or 9% and specialty product revenues of $32.7 million or 49%,
offset by a decrease in professional fees of $11.2 million and investment and
other revenues of $2.1 million.
Total member months for the HMO and insurance subsidiaries decreased
approximately 3%. Commercial and Medicaid HMO member months in total decreased
approximately 4% and managed indemnity member months decreased approximately 9%.
These decreases were partially offset by an increase in Medicare member months
of approximately 7%. In Nevada, commercial and Medicaid HMO member months
remained relatively constant and Medicare member months increased approximately
2%. In Texas, commercial member months decreased approximately 8%, while
Medicare member months increased 30%. Such growth in Medicare member months
contributes significantly to the increase in premium revenues as the Medicare
per member premium rates are over three times higher than the average commercial
premium rate.
The Company's HMO and insurance subsidiaries' average premium rate per member
increased approximately 11% for the nine months ended September 30, 2000
compared to the same period in the prior year. The Nevada commercial and
Medicaid HMO average premium rate per member increased approximately 4% and the
Nevada area Medicare HMO average rate per member increased approximately 9%. The
increase in the Nevada area Medicare HMO rates is primarily due to the Company's
exit from the Arizona Medicare program effective January 1, 2000. The amount of
premium received from HCFA per Medicare member is higher in Las Vegas than in
the Company's Arizona market. HCFA's established rate per member increased 4%
for the Las Vegas area. Over 97% of the Company's Las Vegas Medicare members are
enrolled in the HCFA Social HMO. The Company's premium received from HCFA is
higher for Social HMO members. HCFA might adjust the reimbursement factor for
the Social HMO members in the future. If the reimbursement for these members
decreases significantly and related benefit changes are not made timely, there
could be a material adverse effect on the Company's business. Managed indemnity
premium rates per member increased approximately 12%.
<PAGE>
SIERRA HEALTH SERVICES, INC., AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
Results of Operations, Nine Months Ended September 30, 2000, Compared to Nine
Months Ended September 30, 1999 (continued)
The Texas commercial HMO average premium rate per member increased approximately
15% in the nine months ended September 30, 2000 compared to the same period in
the prior year. Commercial rate increases on renewals were greater than 10% for
Dallas. The Texas Medicare average rate decreased approximately 2% primarily due
to an increase in Medicare membership in Dallas and certain counties in Houston,
which has a lower rate than most of the Company's Medicare members in the
Beaumont area outside of Houston.
As part of the Company's reorganization, it will no longer actively market its
HMO Medicare product in Texas for the remainder of calendar year 2000. The
Company will continue to enroll Medicare eligible members who proactively seek
coverage in Texas and will continue customer service to its existing membership
through 2000. The Company has notified HCFA, that effective January 1, 2001, it
will cease its Medicare products in 14 counties in the Houston area, which will
affect approximately 1,500 members.
The Company markets its HMO and managed indemnity insurance products primarily
to employer groups, labor unions and individuals enrolled in Medicare, through
its internal sales personnel and independent insurance brokers. Such brokers
receive commissions based on the premiums received from each group. The
Company's agreements with its member groups are usually for twelve months and
are subject to annual renewal. For the nine months ended September 30, 2000, the
Company's ten largest commercial HMO employer groups were, in the aggregate,
responsible for less than 10% of its total revenues. Although none of such
employer groups accounted for more than 2% of total revenues for that period,
the loss of one or more of the larger employer groups could, if not replaced
with similar membership, have a material adverse effect on the Company's
business.
Military contract revenues increased to $238.5 million from $218.2 million or
9%. The increase in revenue is primarily attributable to additional accrued bid
price adjustment revenues related to a true-up of prior periods' information
received from the government in the third quarter 2000. Partially offsetting
this was a decrease recorded in the first quarter for a reduction in the at-risk
health care population of beneficiaries as additional beneficiaries enrolled
with military treatment facility primary care managers. The Company is not
at-risk for those TRICARE eligibles and receives less revenue related to them
from the government.
Specialty product revenues increased $32.7 million or 49% to $98.9 million, for
the nine months ended September 30, 2000, compared to the same prior year
period. Specialty product revenues and expenses are primarily related to the
workers' compensation insurance business. The increase in specialty product
revenues related to the workers' compensation insurance segment was primarily
due to premium growth, which has occurred since July 1999 and premium rate
increases for California policies issued in 2000, which have averaged over 30%
on renewal policies, as well as new business in Nevada and Colorado. Beginning
in July 1999, the State of Nevada allowed private insurance companies to offer
workers' compensation products. In addition, premiums ceded under the low-level
reinsurance agreement are decreasing as it is in run-off starting July 1, 2000.
Professional fees were $29 million for the nine months ended September 30, 2000,
a decrease of $11.2 million or 28% compared to the prior year period.
The reduction is due to the sale of the pharmacy operations in Texas in the
fourth quarter of 1999, the closure of inpatient operations at Mohave Valley
Hospital in the first quarter of 1999 and the staffing reductions at the
Company's affiliated medical groups in Texas and Arizona.
Investment and other revenues decreased $2.1 million over the comparable prior
year period primarily due to a decrease in invested balances. Approximately
$739,000 of the difference was due to net realized losses recognized in the
current year of $892,000 compared to net realized losses of $153,000 in the
prior year period.
Total medical expenses increased $91.8 million to $630.9 million over the same
nine-month period last year. Included in medical expenses for the nine months
ended September 30, 2000, are $30.5 million for reserve strengthening, primarily
for adverse development related to prior periods' medical claims, $15.5 million
of additional premium deficiency for Texas operations and $10.2 million of other
non-recurring medical costs, the majority of which were recorded in the second
quarter. Included in medical expenses for the nine months ended September 30,
1999 is $8.1 million of premium deficiency expense for Arizona and rural Nevada
counties, which was recorded in the first quarter. Excluding these items,
medical expenses increased $43.6 million or 8%, and the Medical Care Ratio
increased from 81.1% to 83.4% for the nine months ended September 30, 2000
compared to the same prior year period. The increase in the Medical Care Ratio
is primarily due to the increase in Medicare members as a percentage of fully
insured members. The cost of providing medical care to Medicare members
generally requires a greater percentage of the premiums received. In addition,
hospital costs in southern Nevada were higher primarily due to an increase in
bed days and in Houston, hospital costs were higher due to increased cost of
care.
Included in medical expenses is the utilization of $16.4 million of premium
deficiency reserve to offset losses on contracts in Texas for the nine months
ended September 30, 2000 compared to a utilization of $25.2 million in the same
prior year period. Also included in medical expenses for the nine months ended
September 30, 1999 is the utilization of $6.7 million of premium deficiency
reserve to offset losses primarily on Medicare risk members in Arizona and rural
Nevada.
Total military contract expenses increased approximately $22.6 million, or 11%.
The increase is consistent with the increase in revenues discussed previously.
Specialty product expenses increased $53.6 million or 87% over the same prior
year period. The combined ratio for the workers' compensation insurance business
for the nine months ended September 30, 2000 was 121.0% compared to 95.4% for
the comparable prior year period. The increase was due to an increase in the
loss and LAE ratio to 92.4% from 59.8% in 1999, partially offset by a decrease
in the expense ratio to 26.8% from 35.6% in 1999. The remaining variance is due
to policyholders' dividends incurred for participating policies issued in the
state of Nevada. The policyholders' dividend ratio in 2000 was 1.8%, while no
dividends were incurred in 1999.
The higher loss and LAE ratio for 2000 is due to $20.7 million in adverse
development related to accident years 1999 and prior. In the first nine months
of 1999, no prior accident year development was incurred. Estimated ultimate
losses and LAE incurred in accident years 1996 to 1998 have developed
significantly in response to the continuation of increasing claim severity
patterns on the Company's California book of business. Many workers'
compensation insurance carriers in California are experiencing higher claim
severity. For claims occurring on and after July 1, 1998, the Company has
reinsured a percentage of the higher claim severity to its reinsurer under the
Company's low-level reinsurance agreement. The low-level reinsurance agreement
expired on June 30, 2000; however, the Company opted to continue ceding premiums
and losses under the agreement on a run-off basis for all policies in force on
June 30, 2000. On July 1, 2000, the Company entered into a reinsurance agreement
that covers losses on claims in excess of $250,000 for policies issued after
June 30, 2000.
The reduction in the expense ratio is due to the higher premium volume earned in
2000 compared to 1999. For the nine months ended September 30, 2000, net
premiums earned were $91.0 million or 56% higher than the comparable period in
1999. As a percentage of net premiums earned, policy acquisition costs, which
are comprised of commissions, premium taxes and boards and bureaus expense,
decreased to 9.5% from 9.9% in 1999, and non-policy acquisition expenses
decreased to 17.3% from 25.7% in 1999. Total non-policy acquisition expenses
were $15.7 million compared to $15.0 million in 1999, an increase of 5%. Gross
premiums earned for 2000 increased from $103.7 million in 1999 to $150.2 million
in 2000, an increase of 45%.
General, administrative and marketing ("G&A") costs increased $523,000 or less
than 1% compared to the same period in 1999. As a percentage of total revenues,
G&A costs for the first nine months of 2000 decreased to 9.9% from 10.7% in 1999
due primarily to the higher revenues in the period. As a percentage of medical
premium revenues, G&A costs represent 15.7% for the 2000 period and 16.7% for
the 1999 period. Excluding the utilization of premium deficiency reserves for
maintenance costs of $9.4 million for the nine months ended September 30, 2000
and $15.5 million for the same prior year period, G&A costs decreased by $6.3
million or 5.3%. A $1.9 million increase in depreciation and amortization
expense, primarily related to the implementation of new computer systems, was
offset by decreases in other G&A expenses, primarily related to Texas
operations.
In the first nine months of 2000 and 1999, the Company incurred certain asset
impairment, restructuring and other costs. See Note 2 to the condensed
consolidated financial statements for a discussion of these charges.
Interest expense and other increased $4.5 million or 36% for the nine months
ended September 30, 2000, compared to the same prior year period primarily due
to an increase in debt as well as an increase in the Company's cost of
borrowing.
For the current year period, the Company recorded $75.5 million of tax benefit
for an effective tax rate of 27.2% compared to 33.3% for the same prior year
period. The Company's effective tax rate is less than the 35% statutory rate
primarily due to the non-deductibility of certain portions of goodwill
impairment expense in the second quarter of 2000. Excluding the effect of the
expenses discussed in Notes 2 and 8 to the Condensed Consolidated Financial
Statements, the effective tax rate for the nine months ended September 30, 2000
was 33.2%. The Company's ongoing effective tax rate is less than the 35%
statutory rate primarily due to tax preferred investments.
<PAGE>
SIERRA HEALTH SERVICES, INC., AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources
The Company had negative cash flows from operations of $30.5 million for the
nine months ended September 30, 2000, resulting primarily from a loss of $202.5
million and a net change in assets and liabilities of $57.6 million, which were
offset by a non-cash impairment provision of $203.0 million, $23.6 million in
depreciation and amortization and $3.0 million in provision for doubtful
accounts. The decrease in cash flow resulting from the changes in assets and
liabilities was primarily due to increases in deferred tax assets of $59.2
million primarily related to the charges discussed in Note 2 to the Condensed
Consolidated Financial Statements. Other significant changes in assets and
liabilities cash outflows were: increase in reinsurance recoverable of $73.9
million, primarily due to increased business as well as development on prior
years' loss estimates; increase in gross military accounts receivables of $37.0
million; and a reduction in unearned premiums of $23.6 million due to the late
Medicare payment from HCFA for October of approximately $29.1 million. These
cash outflows were partially offset by an increase in losses and LAE reserves
of $91.5 million, due to increased workers' compensation business, and an
increase in military health care payable of $25.1 million.
Sierra Military Health Services, Inc., ("SMHS") receives monthly cash payments
equivalent to one-twelfth of its annual contractual price with the Department of
Defense ("DoD"). SMHS also accrues revenue on a monthly basis for the
contractually specified Bid Price Adjustment ("BPA") process and for contract
change orders.
The BPA process serves to adjust the DoD's monthly payments to SMHS because such
payments are based in part on DoD estimates for beneficiary population,
beneficiary population baseline health care cost, inflation and military direct
care system utilization. As actual information has been made available for the
above items, quarterly adjustments are made to SMHS' monthly health care payment
in addition to lump sum adjustments for past months. During April 2000, the
Company completed BPA's 2 and 3 with the DoD resulting in a cash payment to the
Company of $13.0 million during the second quarter. On November 3, 2000, SMHS
received a subsequent payment of approximately $17 million associated with a
partial settlement with the DoD on BPA's 4 through 7.
As SMHS implements DoD-directed contract change orders, revenue is accrued on a
percentage of completion basis until price negotiations are settled. In the
second quarter, the Company received payments from the DoD of $6.0 million
related to three specific change orders and an additional $4.0 million in the
third quarter.
At June 30, 2000, the Company was not in compliance with certain financial
covenants relating to its line of credit. The borrowed amount outstanding on the
line of credit as of September 30, 2000 was $185 million. Under the terms of its
line of credit, noncompliance with the covenants constitutes an event of
default, which permits the Company's lenders to accelerate repayment of the
Company's outstanding obligations under its line of credit. The lenders waived
the Company's compliance with these covenants under its line of credit. The
waiver was effective as of June 30, 2000 and, as extended, expired on October
31, 2000. The Company was unable to reach terms with the lenders on the fees and
length of a new waiver and received a Notice of Default on November 8, 2000 from
its lenders with respect to the Company's compliance with the financial
covenants. The waivers included amendments (fourth through sixth) to the line of
credit, which, among other things, required that the Company grant its lenders a
security interest in certain personal property of the Company, reduced the
availability under the line of credit to $185 million, increased the Company's
borrowing rate by 287.5 basis points with interest to be paid monthly and
provided for the payment of additional fees by the Company. In addition, the
fourth amendment provided for a guaranty of the debt by the majority of the
Company's wholly-owned non-regulated subsidiaries, including CII Financial,
Inc., but excluding Sierra Military
Health Services, and for the pledge of common stock of a majority of the
Company's wholly-owned subsidiaries, excluding CII Financial, Inc., and
its subsidiaries.
<PAGE>
SIERRA HEALTH SERVICES, INC., AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
Liquidity and Capital Resources (continued)
With the expiration of the waiver on October 31, 2000, the Company is continuing
to pay interest at the default rate of LIBOR plus 5.25%. There can be no
assurances that a new amendment with revised covenants will be obtained.
Notwithstanding the expiration of the waiver, the Company is currently
negotiating a further amendment to its line of credit
with its lenders, to minimize the potential for future covenant defaults.
While the Company believes that its best interests, and those of its
lenders, would be served through an amendment to the line of credit, there can
be no assurance that such an amendment will ultimately be consummated, or that
in the event the Company does obtain such an amendment to its line of credit,
the Company will be able to maintain compliance with its covenants. In the
meantime, the Company has been aggressively exploring various strategic options,
and has been taking steps to conserve and manage its cash flow; however, there
is no assurance that these actions will be successful.
In accordance with Statement of Financial Accounting Standards No. 78,
"Classification of Obligations that are Callable by the Creditor", the Company
has classified the entire outstanding balance under its line of credit as a
current liability as of September 30, 2000.
During the nine months ended September 30, 2000, the Company had net borrowings
of $25.0 million under its line of credit, which was offset by $7.0 million used
for the reduction of other debt. In addition to the borrowings, cash inflows in
the nine months ended September 30, 2000 included a $23.4 million net change in
investments and $1.6 million received in connection with the sale of stock
through the Company's stock plans. Offsetting the above cash inflows was $13.6
million in net capital expenditures including costs associated with the
Company's technology initiatives to improve new systems and to establish
web-based applications. In March 2000, the Company sold its interest in TriWest
Healthcare Alliance in exchange for a note receivable in the amount of $3.7
million. This note is payable in six monthly installments starting at the end of
October 2000.
The Company has a revised 2000 capital budget of under $20.0 million, primarily
for computer hardware and software, furniture and equipment and other
requirements due primarily to the Company's computer system initiatives. The
Company's liquidity needs over the next six months will primarily be to fund
anticipated temporary negative cash flow at SMHS, restructuring and other
related run-off costs in Texas (see Note 2 to the Company's Condensed
Consolidated Financial Statements), and for the debt service and capital items
noted above.
As part of its initiative to reduce the Texas funding requirements, in October
2000, the Company entered into an agreement to sell certain assets of its
Houston operations. The transaction is anticipated to close prior to the year
end and will reduce on-going cash flow losses of approximately $1.0 to $1.5
million per month. However, run-off costs for healthcare claims and other costs
are anticipated to be approximately $7 million which would be paid over the
following nine to twelve months. In addition, the Company completed the asset
sale of its affiliated Texas medical group in October 2000. Run-off costs
associated with this sale are expected to exceed $5 million with most costs paid
in the following nine to twelve months.
To facilitate a reduction of the balance on its line of credit, if an
amendment to its line of credit is successfully negotiated, the Company
anticipates or has accomplished the following actions:
o Sale and/or lease of the Company's Texas and Arizona real estate
o Asset securitization or financing of military receivables, expected to be
completed within 90 days
o Completed the sale of the Company's airplane for $9.5
million in early November 2000
o Sale-leaseback of substantially all of the Company's Nevada real estate,
expected to be completed no later than the first quarter of 2001
Furthermore, the Company has initiated a plan through which an annual overhead
reduction of over $7.0 million is expected. The Company believes the actions
delineated above along with operating cash flow should enable it to fund its
debt service and capital expenditures, as well as meet its liquidity needs.
In the second quarter of 1997, the Company's Board of Directors authorized a
$3.0 million line of credit from the Company to the Company's Chief Executive
Officer ("CEO"). In April 2000, the Company's Board of Directors authorized a
$2.5 million loan from the Company to the CEO which, along with accrued
interest, is due on June 30, 2002. As of September 30, 2000, the aggregate
principal outstanding and accrued interest for both instruments was $5.3
million. All borrowed amounts bear interest at a rate equal to the rate at which
the Company could have borrowed funds under its line of credit facility at the
time of the borrowing plus 10 basis points.
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 $24.0 million as of
September 30, 2000. The HMO and insurance subsidiaries must also meet
requirements to maintain minimum stockholder's equity, on a statutory basis,
ranging from $1.5 million to $5.2 million, as well as minimum risk-based capital
requirements, which are determined annually. Additionally, in conjunction with
the Kaiser-Texas acquisition, Texas Health Choice, L.C., ("TXHC") entered into a
letter agreement with the Texas Department of Insurance whereby TXHC agreed to
maintain a net worth of $20.0 million. Of the cash and cash equivalents held at
September 30, 2000, $41.4 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 the terms of existing management agreements and by dividends.
The holding company will not receive dividends from its regulated subsidiaries
if such dividend payment would cause violation of statutory net worth and
reserve requirements. As of September 30, 2000 and for the remainder of the
year, the payment of any dividends by the HMO and insurance subsidiaries would
require prior approval by the applicable insurance regulators. Remaining amounts
are available on an unrestricted basis.
CII Financial, Inc., a wholly-owned subsidiary that the Company acquired in
1995, has $47.0 million of convertible subordinated debentures (the
"Debentures") due September 15, 2001 and bearing interest at 7 1/2%, which is
due semi-annually on March 15 and September 15. Each $1,000 in principal is
convertible into 25.382 shares of the Company's common stock at a conversion
price of $39.40 per share. The Debentures are general unsecured obligations of
CII Financial and are not guaranteed by Sierra. In August 2000, CII Financial
became a guarantor of the debt owed under the Company's line of credit. In the
event of a demand to perform on the guaranty, the Debentures would be
subordinated to the debt owed under the line of credit. During the nine months
ended September 30, 2000, CII Financial purchased $3.5 million of the Debentures
on the open market.
CII Financial has limited sources for its cash and had to borrow approximately
$365,000 from the Company to make the September 15, 2000 interest payment.
Absent any funding from the Company, CII
Financial would be dependent upon dividends from its subsidiary, California
Indemnity Insurance Company ("California Indemnity") to meet its debt payment
obligations. Currently, California Indemnity cannot pay any dividends without
prior approval by the California Department of Insurance as it has no earned
surplus and it is unlikely that it will have sufficient earned surplus from
which to pay a dividend to CII Financial when the Debentures mature in 2001. It
is also unlikely that the Company will be in a position to lend any or enough
funds to CII Financial to pay the Debentures when they mature due to the current
limitations of the line of credit facility. Accordingly, CII Financial will not
have readily available funds to pay the Debentures when they mature.
CII Financial and the Company are investigating strategies to resolve this
issue. Such strategies include, but are not limited to, refinancing the
Debentures, extending the maturity date, exchanging the Debentures at a
discount for cash and/or equity or spinning off the subsidiary.
There can be no assurances that CII Financial or the Company can
successfully implement a strategy for the repayment or refinancing of the
Debentures.
Membership
The Company's membership at September 30, 2000 and 1999 was as follows:
<TABLE>
<CAPTION>
Number of Members at September 30
2000 1999
---- ----
HMO
<S> <C> <C>
Commercial.................................................. 244,900 257,100
Medicare.................................................... 53,000 50,400
Medicaid (1)................................................ 13,300 12,000
Managed Indemnity............................................. 31,100 37,300
Medicare Supplement........................................... 28,300 27,800
Administrative Services....................................... 282,900 290,300
TRICARE Eligibles............................................. 617,700 610,000
---------- ----------
Total Members................................................. 1,271,200 1,284,110
========= =========
</TABLE>
(1) In prior years, Medicaid was included in commercial membership.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's available for sale investments are substantially owned by the HMO
and insurance subsidiaries. As of September 30, 2000, unrealized holding losses
on available for sale investments have decreased by $4.8 million since the 1999
year end primarily due to a decrease in interest rates, and thus, an increase in
the market value of bonds. The Company believes that changes in market interest
rates, resulting in unrealized holding gains or losses, should not have a
material impact on future earnings or cash flows as it is unlikely that the
Company would need or choose to substantially liquidate its investment
portfolio.
<PAGE>
SIERRA HEALTH SERVICES, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to various claims and other litigation in the ordinary
course of business. Such litigation includes claims of medical malpractice,
coverage related claims 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
these pending legal proceedings should not have a material adverse effect on the
Company's financial condition.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(10.1) Security Agreement dated as of
August 23, 2000 among Sierra Health
Services, Inc., Banks party to
the Credit Agreement and Bank of
America, N.A., as Administrative Agent
(10.2) Guaranty dated as of August 23, 2000 among
Sierra Health Services, Inc., Banks party
to the Credit Agreement and Bank of
America, N.A., as Administrative Agent
(10.3) Waiver and Fourth Amendment to Credit
Agreement dated as of August 14, 2000
among Sierra Health Services, Inc., Banks
party to the Credit Agreement and Bank of
America, N.A., as Administrative Agent
(10.4) Waiver and Fifth Amendment to Credit
Agreement dated as of September 15, 2000
among Sierra Health Services, Inc., Banks
party to the Credit Agreement and Bank of
America, N.A., as Administrative Agent
(10.5) Waiver and Sixth Amendment to Credit Agreement dated October 11,
2000 among Sierra Health Services, Inc., Banks party to the Credit Agreement and
Bank of America, N.A., as Administrative Agent
<PAGE>
SIERRA HEALTH SERVICES, INC., AND SUBSIDIARIES
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (continued)
(10.6) Sierra Health Services, Inc., 1995 Long-Term Incentive
Plan, As Amended and Restated as of May 12, 1998; As amended
December 9, 1999, May 18, 2000, and June 13, 2000
(10.7) Sierra Health Services, Inc., 1995 Non-Employee Directors'
Stock Plan As Amended and Restated through August 10, 2000
(27) Financial Data Schedule
(99) Registrant's current report on Form 8-K dated March 15, 2000,
incorporated herein by reference
(b) Reports on Form 8-K
The Company has not filed any Reports on Form 8-K during
this reporting period.
<PAGE>
SIERRA HEALTH SERVICES, INC., AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the duly
authorized undersigned.
SIERRA HEALTH SERVICES, INC.
(Registrant)
Date: November 14, 2000 /S/ PAUL H. PALMER
Paul H. Palmer
Vice President of Finance,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
