The table below presents our selected consolidated financial information for the years indicated. The table 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 2003 Form 10-K. The selected consolidated financial data below has been derived from our audited Consolidated Financial Statements.
The ratio of earnings to fixed charges for the periods shown has been computed by dividing earnings available for fixed charges (income from continuing operations before income taxes plus fixed charges including capitalized interest) by fixed charges (interest expense including capitalized interest). Interest expense includes the portion of operating rental expense which we believe is representative of the interest component of rental expense.
Years Ended December 31, ----------------------------------------------------- 2003 2002 2001 2000 1999 --------- --------- --------- --------- ---------
Our continuing operations derive revenues from our health maintenance organization, or HMO, managed indemnity plans and military health care services. To a lesser extent, we also derive revenues from professional fees (consisting primarily of fees for providing health care services to non-members, co-payment fees received from members and ancillary products), and investment and other revenue (consisting of fees for workers' compensation third party administration, utilization management services and ancillary products).
Our Military Health Services Operations segment represented 31.5% of our 2003 operating revenues and 11.2% of our 2003 operating income from continuing operations. This segment had income before income taxes of $14.9 million in 2003 compared to $15.5 million in 2002. However, if we exclude the T-Nex related expenses, the Military Health Services Operations segment would have had income before income taxes of $24.3 million in 2003 compared to $20.5 million in 2002. The improvement was due to greater administrative operating expense efficiencies. We did not win the T-Nex North Region contract and our appeal to the United States General Accounting Office was denied in December 2003. Health care services under our current TRICARE contract for Region 1 will end on August 31, 2004 and we will then have a six-month phase-out at substantially reduced revenues and earnings.
Our cash flows from operating activities of continuing operations increased by 11.1% to $151.9 million and were mainly attributable to the increase in net income. In March 2003, we issued $115.0 million aggregate principal amount of 2¼% senior convertible debentures due March 15, 2023, paid off our old credit facility balance and obtained a new $65 million revolving credit facility, which we have not yet utilized. The senior convertible debentures can be converted into 6.3 million shares of our common stock at a price of $18.29 per share. To help compensate for the potential dilution of the senior convertible debentures, we purchased, as of December 31, 2003, at prevailing prices in the open market by block purchase or private transactions, 5.3 million shares at an average cost of $18.66 per share. In January 2004, we obtained an amendment to our credit facility to allow for up to $60 million of additional purchases of our common stock and as of March 1, 2004, we have purchased an additional 708,000 shares for $22.6 million.
Discontinued Operations. During the third quarter of 2001, we announced our plan to exit the Texas HMO health care market and received formal approval from the Texas Department of Insurance to withdraw our HMO operations in mid-October 2001. We ceased providing HMO health care coverage in Texas on April 17, 2002. As part of our plan to exit Texas, in the third quarter of 2001, we recorded a charge of $17.1 million for premium deficiency costs, the write down of certain assets, legal and restitution costs, and various other exit related costs.
On January 15, 2003, we announced that we were exploring strategic alternatives to dispose of CII. Sierra's Board of Directors approved the sale of the operations on December 31, 2002. Accordingly, beginning in the fourth quarter of 2002, we reclassified our workers' compensation insurance business as discontinued operations.
In the second quarter of 2003, we recorded $4.0 million, $2.6 million after tax, in additional valuation adjustments. On November 25, 2003, we announced that we had reached an agreement to sell California Indemnity Insurance Company, or Cal Indemnity, and its subsidiaries. Cal Indemnity is a wholly-owned subsidiary of CII and is CII's only significant asset. As part of the purchase agreement, Cal Indemnity and its subsidiaries have stopped issuing new or renewal policies except in Nevada. The buyer intends to
place Cal Indemnity and its subsidiaries in run-off. An independent third party claims administrator has been engaged to administer the claims when the transaction is consummated. The transaction was initially valued at $79.5 million, consisting of $15.5 million payable at closing and a contingent payment of $64.0 million which will be payable in 2010. The cash payable at closing is subject to certain adjustments and the contingent payment can be increased or decreased based upon favorable or adverse loss and allocated loss adjustment expense development from closing through December 2009. We have currently estimated that the adjustments will reduce the net sales proceeds to approximately $73 million. In the fourth quarter of 2003, we recorded a charge of $15.6 million, gross and net of tax, to write down the investment in Cal Indemnity to its estimated net sales proceeds. The sale is subject to regulatory approvals and is expected to close by April 30, 2004.
Under the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, or MMA, and effective March 2004, we have calculated that the MMA will increase our Medicare premium rates by over 15%. The increased funding must be used in one or more of the following ways: to reduce beneficiary premiums; reduce beneficiary cost sharing; enhance benefits; placed into a benefit stabilization fund; or used to retain providers or expand the provider network as long as the provider network stabilization or enhancement does not result in increased premiums, increased cost sharing or reduced benefits. We proposed to use the additional funding to enhance various plan benefits, including a reduction in the
Professional Fees increased from $30.9 million to $37.4 million, an increase of $6.5 million, or 20.8% as a result of increased visits due to membership growth, a higher percentage of members selecting our owned medical group and an increase in related services performed by our other provider subsidiaries.
increases at our medical provider subsidiary. The number of days in claims payable, which is the medical claims payable balance divided by the average medical expense per day for the period, at December 31, 2003 was 50.0 compared to 49.6 at December 31, 2002.
We contract with hospitals, physicians and other independent contracted providers of health care under capitated or discounted fee-for- service arrangements, including hospital per diems, to provide medical care services to members. Capitated providers are at risk for a portion of the cost of medical care services provided to our members in the relevant geographic areas; however, we are ultimately responsible for the provision of services to our members should the capitated provider be unable to provide the contracted services. We incurred capitation expenses of $101.8 million and $88.8 million, or 13.3% and 12.5%, of our total medical expenses for 2003 and 2002, respectively.
Military Contract Expenses increased from $360.4 million to $452.6 million, an increase of $92.2 million or 25.6%. The increase is consistent with the increase in revenues discussed previously and includes $9.4 million in T-Nex related costs for 2003 compared to $5.1 million in 2002. Health care delivery expense consists primarily of costs to provide managed health care services to eligible beneficiaries in accordance with Sierra's TRICARE contract. Under the contract, SMHS provides health care services to approximately 707,000 eligible individuals of active duty military personnel, military retirees under the age of 65 and dependents of military retirees through a network of approximately 49,700 health care providers and certain other subcontractor partnerships. Also included in military contract expenses are costs incurred to perform specific administrative services, such as health care appointment scheduling, enrollment, medical and network management services as well as health care advice line services, and other administrative functions of the military health care subsidiary. These administrative services are performed for active duty personnel and family members as well as retired military families.
resulted in expense of approximately $200,000 for 2003 compared to income of approximately $55,000 for 2002.
Provision for Income Taxes was recorded at $44.6 million for 2003 compared to $22.1 million for 2002. The effective tax rate for 2003 was 35.2% compared to 34.3% for 2002. Our effective tax rate is greater than the statutory rate due primarily to an increase in state income taxes.
Discontinued Operations consist of our Texas HMO health care operations and the CII workers' compensation operations. The net loss from discontinued operations for 2003 was approximately $19.8 million compared to $5.9 million for 2002. The Texas HMO health care operations had net income of approximately $3.1 million for 2003, which was offset by a net loss on the CII workers' compensation operations of $22.9 million.
Excluding the $15.6 million charge, expenses decreased in the CII workers' compensation operations by approximately $65.8 million or 31.2%. The decrease is primarily due to the following:
A $42.1 million reduction in loss and LAE is related to the decrease in net earned premiums in 2003 compared to 2002.
The net decrease in underwriting expenses, policyholders' dividends and other operating expenses was approximately $8.0 million and is attributable to the lower premium revenue for the period.
The loss and LAE reserves recorded as of December 31, 2003 reflect our best estimate of the ultimate loss costs for reported and unreported claims occurring in accident year 2003 as well as those occurring in accident years prior to 2003. Workers' compensation claim payments are made over several years from the date of the claim. Until the final payments for reported claims are made, reserves are invested to generate investment income.
The combined ratio is a measurement of the workers' compensation underwriting profit or loss and is the sum of the loss and LAE ratio, underwriting expense ratio and policyholders' dividend ratio. A combined ratio of less than 100% indicates an underwriting profit. Our combined ratio was 118.9% compared to 119.6% for 2002. The decrease was primarily due to a decrease in the loss and LAE ratio. Excluding prior accident years' adverse loss development, the combined ratio would have been 105.2% for 2003 and 106.0% for 2002.
New California workers' compensation insurance reform legislation was signed into law in September 2003 to address some of the cost drivers that have led to significantly higher workers' compensation insurance premium rates over the past three years. The Workers' Compensation Insurance Rating Bureau, or WCIRB, has preliminarily indicated that the reform legislation will reduce the 2004 loss costs by an average of 2.9% to 5.3%. Prior to the enactment of the legislation, the WCIRB had indicated that 2004 loss costs should increase by an average of 12%. We have not adjusted our reserving methods and there is no assurance that our rates are adequate given the inherent uncertainties in any new legislation.
$500,000 per occurrence but the maximum coverage has been reduced from statutory (i.e., unlimited) limits to $20.0 million per occurrence. We also must meet certain annual aggregate deductibles before we can begin to recover from some of our reinsurers. This new coverage will result in our retaining more of the losses and LAE.
Medical Premiums from our HMO and managed indemnity insurance subsidiaries increased from $719.0 million to $857.7 million, an increase of $138.7 million or 19.3%. The increase in premium revenue reflects a 5.1% increase in Medicare member months (the number of months individuals are enrolled in a plan), a 52.2% increase in Medicaid member months and a 20.4% increase in commercial member months. The growth in Medicare member months contributes significantly to the increase in premium revenues as the Medicare per member premium rates are more than three times higher than the average commercial premium rate.
Military Contract Revenues increased from $338.9 million to $373.6 million, an increase of $34.7 million or 10.2%. The increase in revenue is primarily the result of additive change order work and is significantly offset by increased military contract expenses associated with those change orders. In addition, the 2001 revenue included final bid price adjustments on the first two completed option periods of the TRICARE Region 1 contract. The final adjustments resulted in revenue reductions of approximately $300,000 for Option Period 1 (June 1998 to May 1999), which is 0.2% of the final revenue settlement amount for that period and $1.8 million for Option Period 2 (June 1999 to May 2000), which is 0.9% of the final revenue settlement amount for that period. The impact on the 2001 net income for the final bid price adjustments for the first two completed option periods, net of corresponding expense adjustments noted below, was a reduction of $1.0 million. There were no final settlements of bid price adjustments in 2002.
Congressional changes to the program. SMHS administers the expanded benefits only to the over age 65 retiree military population. SMHS does not directly fund claims payment or bear any health care underwriting risk on these program modifications for the actual level of health care service utilization and does not record any claim payments or related revenue on these program modifications.
Investment and Other Revenues decreased from $16.6 million to $16.4 million, a decrease of approximately $200,000 or 1.3% due primarily to a decrease in the average investment yield during the period offset by an increase in the average invested balance.
Medical Expenses increased from $608.8 million to $712.3 million, an increase of $103.5 million or 17.0% due primarily to our increased membership. Medical expenses, as a percentage of medical premiums and professional fees, decreased to 80.2% from 81.4%. The decrease is primarily due to premium yields in excess of cost and utilization increases and favorable claims development from prior periods, which were partially offset by higher bed days in 2002. Included in medical expenses is favorable development on prior years' estimates of $10.9 million and $7.5 million for the years ended December 31, 2002 and 2001, respectively. The favorable development is a result of claims being settled for amounts less than originally estimated.
Military Contract Expenses increased from $331.6 million to $360.4 million, an increase of $28.8 million or 8.7%. The increase is consistent with the increase in revenues discussed previously. In addition, the 2001 contract expenses included final bid price adjustments on the first two completed option periods of the TRICARE Region 1 contract. The final adjustments resulted in a contract expense increase of approximately $600,000 for Option Period 1, which is 0.3% of the final contract expense settlement amount for that period and a contract expense reduction of $1.2 million for Option Period 2, which is 0.6% of the final contract expense settlement amount for that period. There were no final settlements of bid price adjustments in 2002.
revolving credit facility. Interest expense related to the sale-leaseback transaction decreased by $4.9 million as the remaining buildings qualified as a sale during 2002. We had various increases in interest expense of approximately $600,000.
Other Income (Expense), Net increased $2.2 million primarily due to a net loss on sale of assets of $2.3 million in 2001.
Discontinued CII workers' compensation operations. The discontinued workers' compensation operations for 2002 had a loss of $14.4 million compared to a profit of $2.0 million in 2001. The 2002 results included valuation adjustments of $17.3 million, or $11.3 million after tax. Net earned premiums increased by $3.0 million or 1.7% due primarily to a decrease in ceded reinsurance premiums of $12.9 million that was partially offset by a $9.9 million decrease in gross earned premiums. Gross written premiums decreased by $10.7 million due primarily to reduced California premium writings.
The net decrease in underwriting expenses, policyholders' dividends and other operating expenses, excluding the valuation adjustments, was approximately $100,000.
The net adverse loss development on prior accident years included those years that were covered by our low level reinsurance agreement. This resulted in an increase in the reinsurance recoverable balance, which is then reduced by amounts collected from reinsurers. During the year ended December 31, 2002, we increased our ceded reserves by $45.9 million and received payments from our reinsurers totaling $74.6 million.
a source of cash due to the decrease in the deferred tax asset balance of $32.7 million
a source of cash due to the increase in other liabilities of $9.0 million
a source of cash due to the increase in other current liabilities of $21.3 million
a source of cash due to the increase in military health care payable balance of $11.4 million
SMHS receives monthly cash payments equivalent to one-twelfth of its annual contractual price with the Department of Defense, or DoD. SMHS accrues health care revenue on a monthly basis for any monies
The loss of the T-Nex contract will adversely affect our cash flow from operations starting in the fourth quarter of 2004. During the phase-out period, we expect that SMHS will have negative cash from operations as the payout of the remaining liabilities will exceed SMHS' accounts receivable balance.
Net cash used for investing activities of continuing operations during 2003 included $21.8 million in capital expenditures associated with the continued implementation of new computer systems, leasehold improvements on facilities, furniture and equipment and other capital purchases to support our growth. This was offset by net proceeds of $3.3 million from property and equipment dispositions. The net cash change in investments for the year was an increase in investments of $12.5 million as investments were purchased with available funds.
Net cash used for financing activities of continuing operations during 2003 included net payments of $60.7 million on debt related items offset by $115.0 million in proceeds from the sale of our senior convertible debentures and $1.5 million from proceeds of other long-term debt. These proceeds were offset by debt issue costs of $5.8 million. Proceeds from the issuance of stock in connection with stock plans were $19.2 million. We used cash of $99.5 million to purchase treasury stock.
Discontinued operations used cash of $17.8 million in 2003, compared to $47.9 million in 2002. Cash used in 2003 was primarily for the payoff of the remaining Kaiser-Texas mortgage loan for $12.9 million and the redemption of the outstanding 9½% senior debentures for $15.3 million. Cash used in 2002 was primarily for the run-out of claims and other legal and restitution related items. Based on the current estimated Texas HMO health care run-out costs and recorded reserves, we believe we have adequate funds available and the ability to invest, should we be required to do so, adequate funds in Texas to meet the anticipated obligations for our former members' health care claims.
The aggregate offering price of the debentures was $115.0 million, 100% of the principal amount thereof. The purchase price paid to the Company by the initial purchasers was the initial offering price less a discount of $3.5 million or 3.0% of the principal amount of the debentures. The Company used the net proceeds of the offering to repay the $39.0 million outstanding under the then existing credit facility and to contribute $35.0 million to SMHS. The Company also used $19.9 million of the proceeds to purchase 1.6 million shares of the Company's common stock under its repurchase program. The remainder of the net proceeds were used for working capital and general corporate purposes including additional share repurchases.
expenditures and otherwise restricts certain corporate activities. In addition, we are required to comply with specified financial ratios as set forth in the new credit agreement. We believe that we are in compliance with all covenants of the new credit agreement.
The following schedule represents our obligations and commitments for long-term debt, capital leases and operating leases at December 31, 2003. The amounts presented below include all future payments associated with each obligation including interest expense.
Long- Term Capital Operating Debt Leases Leases Total ----------- ------------ --------- --------- (In thousands) Continuing Operations Payments due in less than 1 year...... $ 2,684 $ 117 $ 21,384 $ 24,185 Payments due in 1 to 3 years.......... 5,368 144 40,171 45,683 Payments due in 4 to 5 years.......... 6,146 101 36,408 42,655 Payments due after 5 years............ 148,918 123 117,471 266,512 ----------- ------------ --------- --------- Total Continuing Operations...... $ 163,116 $ 485 $ 215,434 $ 379,035 =========== ============ ========= ========= Discontinued Operations Payments due in less than 1 year...... $ -- $ 235 $ 777 $ 1,012 Payments due in 1 to 3 years.......... -- -- 1,388 1,388 Payments due in 4 to 5 years.......... -- -- 969 969 Payments due after 5 years............ -- -- -- -- ----------- ------------ --------- --------- Total Discontinued Operations.... $ -- $ 235 $ 3,134 $ 3,369 =========== ============ ========= =========
At December 31, 2002, our Chief Executive Officer, or CEO, had loans outstanding to us in the amount of $4.2 million with a maturity date of December 31, 2003. During 2003, our CEO paid the entire outstanding balance including accrued interest.
While we are unable to predict what legislative or regulatory changes may occur or the impact of any particular change, our operations and financial results could be negatively effected by any legislative or regulatory requirements. For example, any proposals to eliminate or reduce the Employee Retirement Income Security Act, or ERISA, which regulates insured and self- insured health care coverage plans offered by employers, pre-emption of state laws that would increase litigation exposure, affect underwriting practices, limit rate increases, require new or additional benefits or affect contracting arrangements (including proposals to require HMOs and PPOs to accept any health care provider willing to abide by an HMO's or PPO's contract terms) may have a material adverse effect on our business. The continued consideration and enactment of "anti-managed care" laws and regulations by federal and state bodies may make it more difficult for us to manage medical costs and may adversely affect financial results.
In addition to the items described above, we urge you to review carefully the section "Risk Factors" in Part 1, Item 1 of this 2003 Form 10-K for a more complete discussion of the risks associated with an investment in our securities. See "Note on Forward-Looking Statements and Risk Factors" under Item 1.
Medical Premiums and Expenses. Medical premium revenues are recorded in the month when we are obligated to provide services to our enrolled members. Premiums received in advance of the coverage period are recorded as unearned premiums. Our premium revenues are net of an estimate for an allowance for retroactive adjustments. At December 31, 2003, our allowance for retroactive adjustments for health care premium revenues was $2.2 million. Retroactive adjustments result from changes in enrollments that relate to prior periods due to delays in processing or reporting by employers. We use historical trends and known activities to estimate our premium allowances. Any subsequent difference between actual premium adjustments and previously estimated premium adjustments would be reflected in that subsequent year's operating results.
Investment Securities. At December 31, 2003, we had total investments for continuing operations of $215.2 million. All of these investments are classified as available-for-sale and are presented at fair value. Except for restricted cash and investments, which totaled $17.6 million at December 31, 2003, and are reported as non-current assets, the remainder of these investments of $197.6 million are available to support current operations and are therefore reported as current assets.
Our discontinued operations had total investments of $247.7 million of which $244.2 million was classified as available-for-sale and the balance of $3.5 million was classified as held-to-maturity. Held-to-maturity investments are reported at amortized cost because we have the intent and ability to hold these investments until they mature.
Workers' Compensation Loss and Loss Adjustment Expenses. Discontinued operations' workers' compensation insurance losses and loss adjustment expenses, or LAE, are 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. Similar to the health care medical expenses, we use a variety of standard actuarial projection methods to make these estimates and we must use our judgment in selecting development factors and assumed trends. Unlike health care medical expenses, where the cost to provide health care services is substantially completed within one year, workers' compensation claims can be paid out over a substantial number of years due to certain lifetime benefits. In addition, the period between when a claim is reported to us and when the injury occurred could be longer than one year and when we are no longer insuring the account. Loss and LAE reserves have a significant degree of uncertainty when related to their subsequent payments. Although our reserves are established on the basis of a reasonable estimate, it is not only possible but also probable that our reserves will differ from their related subsequent developments. Underlying causes for this uncertainty include, but are not limited to, uncertainty in development patterns, unanticipated inflationary trends affecting the cost of services covered by the insurance contract, adverse legal outcomes and new interpretations of laws or regulations or of disputed contract provisions that result in our having to provide new or extended benefits. This uncertainty can result in both adverse as well as favorable development of actual subsequent activity when compared to the reserve established. During the past five years (1999-2003), we have had adverse development in our previously recorded loss and LAE reserves that has ranged from a low of $8.7 million to a high of $24.0 million. Any subsequent change in loss and LAE reserves established in a prior year would be reflected in that subsequent year's operating results.
Management believes, based on information presently available, that the recorded deferred tax assets are reasonable and recoverable. A change between the recorded asset and the subsequently used deferred
tax asset could have a material impact to our business and results of operations. For example, a 1% decrease in the deferred tax asset as of December 31, 2003, could reduce reported net income for the year 2003 by $623,000 or 1.0% and diluted earnings per share would be reduced by $0.02.
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, 2003, such systems and controls were adequate to meet the objectives discussed herein.
As described in Note 20 to the notes to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" as of January 1, 2002.
PROPERTY AND EQUIPMENT, NET.......................................... 63,109 64,868 RESTRICTED CASH AND INVESTMENTS...................................... 17,646 17,557 GOODWILL (Less: Accumulated Amortization $6,972).................... 14,782 14,782 DEFERRED TAX ASSET (Less Current Portion)............................ 11,501 14,947 OTHER ASSETS......................................................... 46,626 33,384 ------------ ------------ TOTAL ASSETS......................................................... $ 1,134,121 $ 1,065,966 ============ ============
2003 2002 2001 ----------- ----------- ----------- OPERATING REVENUES: Medical Premiums.............................................. $ 962,176 $ 857,741 $ 718,994 Military Contract Revenues.................................... 465,313 373,589 338,918 Professional Fees............................................. 37,367 30,923 28,985 Investment and Other Revenues................................. 20,223 16,382 16,603 ----------- ----------- ----------- Total...................................................... 1,485,079 1,278,635 1,103,500 ----------- ----------- ----------- OPERATING EXPENSES: Medical Expenses.............................................. 762,865 712,290 608,757 Military Contract Expenses.................................... 452,554 360,375 331,621 General and Administrative Expenses........................... 137,263 133,979 122,623 ----------- ----------- ----------- Total...................................................... 1,352,682 1,206,644 1,063,001 ----------- ----------- ----------- OPERATING INCOME FROM CONTINUING OPERATIONS............................................... 132,397 71,991 40,499 Interest Expense.............................................. (5,491) (7,650) (15,738) Other Income (Expense), Net................................... (223) 55 (2,119) ----------- ----------- ----------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES...................................... 126,683 64,396 22,642 PROVISION FOR INCOME TAXES.................................... (44,565) (22,088) (7,161) ----------- ----------- ----------- INCOME FROM CONTINUING OPERATIONS............................. 82,118 42,308 15,481 LOSS FROM DISCONTINUED OPERATIONS (net of income tax benefit of $3,578, $2,945 and $5,403)................... (19,792) (5,860) (11,995) ----------- ----------- ----------- NET INCOME.................................................... $ 62,326 $ 36,448 $ 3,486 =========== =========== =========== EARNINGS PER COMMON SHARE: Income From Continuing Operations......................... $ 2.93 $ 1.47 $ 0.56 Loss from Discontinued Operations......................... (0.71) (0.20) (0.43) ----------- ----------- ----------- Net Income................................................ $ 2.22 $ 1.27 $ 0.13 =========== =========== =========== EARNINGS PER COMMON SHARE ASSUMING DILUTION: Income From Continuing Operations......................... $ 2.70 $ 1.36 $ 0.54 Loss from Discontinued Operations......................... (0.65) (0.19) (0.42) ----------- ----------- ----------- Net Income................................................ $ 2.05 $ 1.17 $ 0.12 =========== =========== ===========
Common Stock Issued in Connection with Stock Plans.............................. 2,220 11 (272) 3,896 18,110 -- -- (2,846) 19,171 Income Tax Benefit Realized Upon Exercise of Stock Options..................... -- -- -- -- 12,596 -- -- -- 12,596 Amortization of Deferred Compensation.............. -- -- -- -- -- 451 -- -- 451 Repurchase of Common Shares........................ -- -- 5,330 (99,485) -- -- -- -- (99,485) Comprehensive Income: Net Income...................................... -- -- -- -- -- -- -- 62,326 62,326 Other Comprehensive Income: Unrealized Holding Loss on Available- for-Sale Investments ($4,446 pretax)........ -- -- -- -- -- -- (2,890) -- (2,890) Reclassification Adjustment for Gains Included in Net Income ($1,493 pretax)...... -- -- -- -- -- -- 970 -- 970 Minimum Pension Liability Adjustment ($1,630 pretax).................. -- -- -- -- -- -- 1,060 -- 1,060 ------------- ------------- ---------- Total Comprehensive Income......................... -- -- -- -- -- -- (860) 62,326 61,466 --------- -------- --------- --------- ----------- --------- ------------- ------------- ---------- BALANCE, DECEMBER 31, 2003......................... 33,173 $ 166 6,221 $(112,737) $ 227,417 $ (22) $ (479) $ 36,419 $ 150,764 ========= ======== ========= ========= =========== ========= ============= ============= ==========
2003 2002 2001 ---------- ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income..................................................... $ 62,326 $ 36,448 $ 3,486 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Loss from Discontinued Operations.......................... 19,792 5,860 11,995 Depreciation and Amortization.............................. 15,929 18,245 24,184 Deferred Compensation Expense.............................. 451 585 342 Provision for Doubtful Accounts............................ 3,071 2,835 1,251 Loss on Property and Equipment Dispositions................ 825 17 2,311 Change in Operating Assets and Liabilities: Other Assets............................................... (7,408) (16) 2,839 Deferred Tax Asset......................................... 32,688 37,931 2,107 Other Current Liabilities.................................. 21,345 14,660 3,853 Accounts Receivable........................................ (3,919) 1,267 (2,921) Other Current Assets....................................... (19,097) 6,454 (2,153) Military Accounts Receivable............................... (263) (6,960) 32,436 Military Health Care Payable............................... 11,382 (12,038) (7,598) Medical Claims Payable..................................... 5,718 16,369 7,258 Other Liabilities.......................................... 9,023 14,980 18,774 ---------- ---------- ---------- Net Cash Provided by Operating Activities of Continuing Operations.................................... 151,863 136,637 98,164 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital Expenditures........................................... (21,774) (12,392) (7,136) Property and Equipment Dispositions............................ 3,256 680 7,265 Purchase of Available-for-Sale Investments..................... (540,206) (847,437) (130,625) Proceeds from Sales/Maturities of Available-for-Sale Investments............................. 527,696 712,483 107,540 ---------- ---------- ---------- Net Cash Used for Investing Activities of Continuing Operations.................................... (31,028) (146,666) (22,956) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from Long-term Borrowing.............................. 116,480 -- -- Debt Issue Costs............................................... (5,834) -- -- Proceeds on Sale-Leaseback Deposit............................. -- 16,862 -- Payments on Debt and Capital Leases............................ (60,721) (30,399) (53,187) Purchase of Treasury Stock..................................... (99,485) -- -- Exercise of Stock in Connection with Stock Plans............... 19,171 10,159 2,090 ---------- ---------- ---------- Net Cash Used for Financing Activities of Continuing Operations.................................... (30,389) (3,378) (51,097) ---------- ---------- ---------- NET CASH USED FOR DISCONTINUED OPERATIONS............................ (17,751) (47,929) (45,954) ---------- ---------- ---------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.............................................. 72,695 (61,336) (21,843) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR....................................................... 45,778 107,114 128,957 ---------- ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF YEAR............................. $ 118,473 $ 45,778 $ 107,114 ========== ========== ==========
Principles of Consolidation. All significant intercompany transactions and balances have been eliminated in consolidation. Sierra's consolidated subsidiaries include: Health Plan of Nevada, Inc. ("HPN") and Texas Health Choice, L.C. ("TXHC"), which are 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 provider group; Sierra Military Health Services, Inc., and its subsidiary, ("SMHS"), a company that provides and administers managed care services to certain TRICARE eligible beneficiaries; 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; a home medical products subsidiary; and a company that provides and manages mental health and substance abuse services. CII and TXHC have been reported as discontinued operations.
Military Contract Revenues. Revenue under the Department of Defense TRICARE contract is recorded based on the contract price as agreed to by the federal government. The health care component of the TRICARE contract has a fixed bid price component (established when the contract was awarded based on the government's assumptions regarding enrollment and utilization), as well as a Bid Price Adjustment ("BPA") component. The BPA is used to adjust the fixed bid price health care component up or down over the course of the contract for changes in health care cost trends due to changes in enrollment and utilization patterns from the government's original assumed enrollment and utilization patterns. On a monthly basis, SMHS records the base bid health care revenue component as stated in the original bid and SMHS also records an estimate for the BPA using the latest government provided data. SMHS adjusts each BPA accrual as it is provided with new government data. After each BPA negotiation with the government is completed, SMHS records a final BPA adjustment for the ultimate negotiated amount.
Medical Expenses. Health care expenses 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 yet reported to the Company. The Company uses a variety of standard actuarial projection methods to make these estimates and must use judgment in selecting development factors and assumed trends. In making projections, the Company considers medical cost utilization and trends, changes in internal processes, the average interval between the date services are rendered and the date claims are received and/or paid, denied claims activity, disputed claims activity, seasonality patterns and changes in membership. Assumptions could be affected by the timing of the receipt of claims, the timing of processing claims and unanticipated changes, such as adverse legal outcomes, legislative or regulatory changes, new interpretations of existing laws or regulations or disputed contract provisions that result in
the Company having to provide new or extended benefits and changes in the Company's health care delivery system or costs. The Company believes that the recorded liability for medical claims payable, at December 31, 2003, is reasonable and adequate to cover future health care claim payments. Any subsequent changes in an estimate for a prior year would be reflected in that subsequent year's operating results.
Military Accounts Receivable. Amounts receivable under government contracts are comprised primarily of amounts due from military treatment facilities, estimates of adjustments under the contract based on actual experience and estimates of the earned portion of any change orders not originally specified in the contract.
Reinsurance Recoverable. In the normal course of business, the Company seeks to reduce the effects of catastrophic and other events that may cause unfavorable underwriting results by reinsuring certain levels of risk with other reinsurers. Reinsurance receivable for ceded paid claims is recorded in accordance with the terms of the agreements and reinsurance recoverable for unpaid losses and loss adjustment expense and medical claims payable is estimated in a manner consistent with the claim liability associated with the reinsurance policy. Reinsurance receivables, including amounts related to paid and unpaid losses, are reported as assets rather than a reduction of the related liabilities.
See Note 10 for a discussion of the workers' compensation insurance operations' reinsurance.
Property and Equipment. Property and equipment are stated at cost less accumulated depreciation. Maintenance and repairs that do not significantly improve or extend the life of the respective assets are charged to operations. The Company capitalizes interest expense as part of the cost of construction of facilities and the implementation of computer systems. Depreciation 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:
Goodwill. The goodwill balance at December 31, 2003, was $14.8 million, all of which is part of the managed care and corporate operations segment. During 2003 and 2002, the Company's assessment of goodwill resulted in no impairment of goodwill. Amortization expense, from continuing operations, associated with goodwill was $805,000 for the year ended December 31, 2001. See Note 20 for a pro forma table presenting the results of operations as though SFAS No. 142 occurred as of January 1, 2001.
additional paid-in capital. All sales of treasury shares in 2003 and 2002 were in connection with the exercise of stock options.
Net income per share assuming dilution, as reported..................... $ 2.05 $ 1.17 $ 0.12 Pro forma net income................................... 1.81 1.02 --
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 Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" been applied to all the years of previous option grants. The above numbers do not include the effect of options granted prior to 1995. See Note 16 for a discussion of the assumptions used in the option pricing model and estimated fair value of employee stock options.
In December 2003, the FASB, issued Statement of Financial Accounting Standards No. 132 (Revised 2003), "Employers' Disclosures about Pensions and Other Postretirement Benefits, an amendment of FASB Statements No. 87, 88 and 106" ("Revised SFAS No. 132"). Revised SFAS No. 132 retains the disclosure requirement contained in the original FASB Statement No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits", which it replaces. The statement also requires additional disclosures to those in the original FASB Statement No. 132 about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement plans. See Note 15 for disclosure on our defined benefit plan.
Income from continuing operations................ $ 82,118 $ 42,308 $ 15,481 Loss from discontinued operations................ (19,792) (5,860) (11,995) ----------- ----------- ----------- Net income....................................... $ 62,326 $ 36,448 $ 3,486 =========== =========== =========== Earnings per common share: Income from continuing operations................ $ 2.93 $ 1.47 $ 0.55 Loss from discontinued operations................ (0.71) (0.20) (0.43) ----------- ----------- ----------- Net income....................................... $ 2.22 $ 1.27 $ 0.13 =========== =========== =========== Earnings per common share assuming dilution: Income from continuing operations................ $ 2.70 $ 1.36 $ 0.54 Loss from discontinued operations................ (0.65) (0.19) (0.42) ----------- ----------- ----------- Net income....................................... $ 2.05 $ 1.17 $ 0.12 =========== =========== ===========
Weighted average common shares outstanding....... 28,053 28,756 27,685 Dilutive options outstanding..................... 2,246 2,141 787 Restricted shares outstanding.................... 122 244 37 Weighted average common shares outstanding ----------- ----------- ----------- assuming dilution....................... 30,421 31,141 28,509 =========== =========== ===========
Stock options to purchase 319,000, 325,000 and 1,591,000 shares in 2003, 2002 and 2001, respectively, were not dilutive and, therefore, were not included in the computations of diluted earnings per share. In addition, the Sierra Debentures were not dilutive at any time during the year ended December 31, 2003. See Note 6 for more information on the Sierra Debentures.
Buildings and Improvements....................... $ 245 $ 245 Data Processing Equipment and Software........... 333 333 Vehicles......................................... 153 -- Less: Accumulated Depreciation................... (506) (413) ----------- ----------- Property and Equipment, Net................... $ 225 $ 165 =========== ===========
The following table summarizes the Company's current and restricted investments, from continuing operations, as of December 31, 2002:
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ---------- ---------- (In thousands) Available-for-Sale Investments: Classified as Current: U.S. Government and its Agencies................................ $ 35,338 $ 747 $ 19 $ 36,066 Municipal Obligations........................................... 87,701 21 83 87,639 Corporate Bonds................................................. 54,845 4 -- 54,849 Other Debt Securities........................................... 1,161 4 -- 1,165 ---------- ---------- ---------- ---------- Total Debt Securities........................................ 179,045 776 102 179,719 Preferred Stock................................................. 2,754 20 41 2,733 ---------- ---------- ---------- ---------- Total Current...................................................... 181,799 796 143 182,452 ---------- ---------- ---------- ---------- Classified as Restricted: U.S. Government and its Agencies................................ 8,785 208 -- 8,993 Municipal Obligations........................................... 1,397 43 10 1,430 Other Debt Securities........................................... 7,134 -- -- 7,134 ---------- ---------- ---------- ---------- Total Restricted................................................... 17,316 251 10 17,557 ---------- ---------- ---------- ---------- Total Available-for-Sale.................................. $ 199,115 $ 1,047 $ 153 $ 200,009 ========== ========== ========== ==========
The contractual maturities of available-for-sale debt securities at December 31, 2003 are shown below:
Due in one year or less............................................. $ 70,642 $ 70,709 Due after one year through five years............................... 74,460 74,677 Due after five years through ten years.............................. 33,946 33,225 Due after ten years through fifteen years........................... 9,975 9,973 Due after fifteen years............................................. 24,134 24,034 ---------- ---------- Total.......................................................... $ 213,157 $ 212,618 ========== ==========
Revolving Credit Facility. On March 3, 2003, the Company entered into a new $65.0 million revolving credit facility, which replaced the amended and restated credit facility. The new facility may be increased up to an aggregate amount of $125.0 million upon receipt of new commitments from existing or additional lenders. Interest on the facility was initially LIBOR plus 2.25% and is currently LIBOR plus 2.00%. The facility will expire on April 30, 2006 but can be extended, at the sole discretion of each of the lenders, until March 3, 2008. The new facility is available for general corporate purposes. The Company has not yet utilized this facility.
Other. The Company has obligations under capital leases with interest rates from 6.6% to 12.2%. In
addition, the Company has term loans with the City of Baltimore and the State of Maryland with interest rates of up to 3.0%. If SMHS does not meet the employment requirements of the term loans as of December 31, 2004, the term loans will be required to be repaid on December 31, 2004.
The fair value of long-term debt, including the current portion, is estimated to be approximately $116.8 million based on the borrowing rates currently available to the Company.
As of December 31, 2003, the Company's Board of Directors had authorized a program for the repurchase of up to 7.6 million shares of the Company's common stock. Through December 31, 2003, the Company had purchased, at prevailing prices in the open market by block purchase or private transactions, 5.3 million shares for $99.5 million. As of December 31, 2003, the Company had Board authorization to purchase approximately 2.3 million shares of its common stock.
2003 2002 2001 ---------- ---------- ---------- Statutory Rate...................................................... 35 % 35 % 35 % State Income Taxes.................................................. -- -- (1) Tax Preferred Investments........................................... (1) (1) (1) Change in Valuation Allowance....................................... -- (3) (2) Intangible Amortization............................................. -- -- 1 Compensation and Benefit Plans...................................... -- 3 1 Other............................................................... 1 -- (1) ---------- ---------- ---------- Provision for Income Taxes.......................................... 35 % 34 % 32 % ========== ========== ==========
2003 2002 ---------- ---------- Deferred Tax Assets: (In thousands) Medical Claims Payable and Losses and Loss Adjustment Expense Reserves................... $ 19,165 $ 15,611 Accruals Not Currently Deductible............................... 4,583 16,125 Compensation Accruals........................................... 12,619 11,259 Bad Debt Allowances............................................. 2,780 3,140 Loss Carryforwards and Credits.................................. 18,782 28,696 Depreciation and Amortization................................... -- 3,642 Unearned Premiums............................................... 2,772 2,976 Deferred Reinsurance Gains...................................... 1,647 1,806 Unrealized Investment Losses (Gains)............................ 257 (777) Other........................................................... 105 844 ---------- ---------- Total......................................................... 62,710 83,322 ---------- ---------- Deferred Tax Liabilities: Deferred Policy Acquisition Costs............................... 479 758 Depreciation.................................................... 3,211 -- Other........................................................... 1,682 242 ---------- ---------- Total......................................................... 5,372 1,000 ---------- ---------- Net Deferred Tax Asset.......................................... $ 57,338 $ 82,322 ========== ==========
2003 2002 ---------- ---------- (In thousands) Deferred Tax Assets: Medical Claims Payable.......................................... $ 7,236 $ 4,587 Accruals Not Currently Deductible............................... 4,688 15,162 Compensation Accruals........................................... 12,217 10,772 Bad Debt Allowances............................................. 2,428 2,769 Loss Carryforwards and Credits.................................. 18,249 28,544 Unrealized Investment Losses (Gains)............................ 195 (353) Depreciation and Amortization................................... -- 3,650 Other........................................................... 196 218 ---------- ---------- Total......................................................... 45,209 65,349 ---------- ---------- Deferred Tax Liabilities: Depreciation and Amortization................................... 3,099 -- Other........................................................... 995 849 ---------- ---------- Total......................................................... 4,094 849 ---------- ---------- Net Deferred Tax Asset.......................................... $ 41,115 $ 64,500 ========== ==========
During the second quarter of 2003, a final payment of $12.9 million was made to pay off Kaiser-Texas mortgage loan, resulting in a gain, net of tax, of $1.3 million. During 2003, TXHC sold the four remaining real estate properties for a net loss of $400,000.
During 2002, the Company had favorable development related to its medical claims and reduced its medical claims payable and medical expenses by $9.8 million. The favorable development was partially offset by an increase in the estimate of legal, restitution and other exit related costs of $800,000. The adjustments resulted in income, net of tax, of $5.9 million.
Restructuring Asset and Premium Impair- Reorgan- Deficiency ment ization Maintenance Other Total ----------- ---------------- ------------ --------- --------- (In thousands) Balance, January 1, 2001......... $ -- $ 3,755 $ 9,278 $ 800 $ 13,833 Charges recorded................. 1,600 4,380 570 -- 6,550 Cash used........................ -- (3,716) (1,478) (800) (5,994) Noncash activity................. (1,600) (125) -- -- (1,725) Changes in estimate.............. -- -- (7,800) -- (7,800) ----------- ---------------- ------------ --------- --------- Balance, December 31, 2001....... -- 4,294 570 -- 4,864 Charges recorded................. -- -- -- -- -- Cash used........................ -- (2,490) (570) -- (3,060) Noncash activity................. -- (4,222) -- -- (4,222) Changes in estimate.............. -- 5,000 -- -- 5,000 ----------- ---------------- ------------ --------- --------- Balance, December 31, 2002....... -- 2,582 -- -- 2,582 Charges recorded................. -- -- -- -- -- Cash used........................ -- (909) -- -- (909) Noncash activity................. -- (523) -- -- (523) Changes in estimate.............. -- (1,150) -- -- (1,150) ----------- ---------------- ------------ --------- --------- Balance, December 31, 2003....... $ -- $ -- $ -- $ -- $ -- =========== ================ ============ ========= =========
On January 15, 2003, the Company announced that it was exploring strategic alternatives for its workers' compensation company, CII Financial Inc., ("CII"). Sierra's Board of Directors approved the sale of the operations on December 31, 2002. Accordingly, beginning in the fourth quarter of 2002, the Company reclassified its workers' compensation insurance business as discontinued operations.
adjustment expense development from closing through December 2009. The Company currently estimated that the adjustments would reduce the net sales proceeds to approximately $73 million. In the fourth quarter of 2003, the Company recorded a charge of $15.6 million, gross and net of tax, to write down the investment in Cal Indemnity to its estimated net sales proceeds. The Company did not recognize a tax benefit on the charge since the Company's tax basis was less than our investment in Cal Indemnity. The sale is subject to regulatory approvals and is expected to close by April 30, 2004.
The following are the assets and liabilities of the discontinued operations of CII:
December 31, ------------------------- 2003 2002 ----------- ------------ (In thousands) ASSETS Cash and Cash Equivalents....................................... $ 58,634 $ 23,060 Investments..................................................... 243,647 287,242 Reinsurance Recoverable......................................... 177,333 189,409 Property and Equipment, Net..................................... 1,612 2,167 Other Assets.................................................... 48,320 46,034 ----------- ------------ TOTAL ASSETS.................................................... 529,546 547,912 ----------- ------------
(Loss) Income from Discontinued Operations Before Income Tax .................................. (28,164) (21,838) 3,628
Land............................................. $ 116 $ 116 Buildings and Improvements....................... 1,535 1,522 Furniture, Fixtures and Equipment................ 1 70 Data Processing Equipment and Software........... 20 3,534 Software in Development and Construction in Progress................................... -- 45 Less: Accumulated Depreciation................... (60) (3,120) ----------- ----------- Property and Equipment, Net.................. $ 1,612 $ 2,167 =========== ===========
Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ---------- ---------- (In thousands) Available-for-Sale Investments: Classified as Current: U.S. Government and its Agencies................................ $ 163,384 $ 2,682 $ 423 $ 165,643 Municipal Obligations........................................... 65,454 338 501 65,291 Corporate Bonds................................................. 19,830 49 1,919 17,960 Mortgage Backed Securities....................................... 1,020 47 -- 1,067 Other........................................................... 10,987 46 25 11,008 ---------- ---------- ---------- ---------- Total Debt Securities........................................ 260,675 3,162 2,868 260,969 Preferred Stock................................................. 5,939 210 22 6,127 ---------- ---------- ---------- ---------- Total Current...................................................... 266,614 3,372 2,890 267,096 ---------- ---------- ---------- ---------- Classified as Restricted: U.S. Government and its Agencies................................ 12,489 711 -- 13,200 Municipal Obligations........................................... 974 62 -- 1,036 Corporate Bonds................................................. 756 5 -- 761 ---------- ---------- ---------- ---------- Total Restricted................................................... 14,219 778 -- 14,997 ---------- ---------- ---------- ---------- Total Available-for-Sale.................................. $ 280,833 $ 4,150 $ 2,890 $ 282,093 ========== ========== ========== ==========
The contractual maturities of held-to-maturity investments at December 31, 2003 are shown below:
In addition to the low level reinsurance, effective January 1, 2000, CII entered into a reinsurance contract that provided statutory (unlimited) coverage for workers' compensation claims in excess of $500,000 per occurrence. The contract was in effect for claims occurring on or after January 1, 2000 through December 31, 2002. There was a twelve month run-out provision in the contract, which the Company exercised. The reinsurer, National Union Fire Insurance Company, is rated AAA and A++ by Fitch Ratings and the A.M. Best Company, respectively.
The following table provides workers' compensation prospective reinsurance information for the three years ended December 31, 2003:
Change in Recoveries Recoverable on Paid on Unpaid Premiums Losses/LAE Losses/LAE Ceded ---------- ---------- ---------- (In thousands) Year Ended December 31, 2003: Low level reinsurance carrier...................................... $ 43,818 $ (19,827) $ (27) Excess of loss reinsurance carriers................................ 6,544 10,698 6,136 ---------- ---------- ---------- Total.............................................................. $ 50,362 $ (9,129) $ 6,109 ========== ========== ========== Year Ended December 31, 2002: Low level reinsurance carrier...................................... $ 60,314 $ (37,854) $ (2,184) Excess of loss reinsurance carriers................................ 2,308 19,403 2,617 ---------- ---------- ---------- Total.............................................................. $ 62,622 $ (18,451) $ 433 ========== ========== ========== Year Ended December 31, 2001: Low level reinsurance carrier...................................... $ 80,932 $ (40,430) $ 9,136 Excess of loss reinsurance carriers................................ 4,407 9,125 4,244 ---------- ---------- ---------- Total.............................................................. $ 85,339 $ (31,305) $ 13,380 ========== ========== ==========
During the years ended December 31, 2003, 2002 and 2001, the Company experienced prior year net adverse loss development of $16.9 million, $24.0 million and $8.7 million, respectively. The net adverse
loss development recorded was largely attributable to higher costs per claim, or claim severity, in California. Many workers' compensation insurance carriers in California are also experiencing high claim severity. Factors influencing the higher claim severity include rising average temporary disability costs, the increase in the number of major permanent disability claims, medical inflation and adverse court decisions related to medical control of a claimant's treatment.
Long-Term Debt - Senior Debentures. At September 30, 2000, CII had approximately $47.1 million of subordinated debentures outstanding that were due on September 15, 2001. These subordinated debentures were neither assumed nor guaranteed by Sierra and were subordinated to Sierra's credit facility debt. In December 2000, CII commenced an offer to exchange the subordinated debentures for cash and/or new debentures. On May 7, 2001, CII closed its exchange offer on $42.1 million of its outstanding subordinated debentures. CII purchased $27.1 million in principal amount of subordinated debentures for $20.0 million in cash and issued $15.0 million in new 9½% senior debentures, due September 15, 2004, in exchange for $15.0 million in subordinated debentures. The remaining $5.0 million in subordinated debentures were paid at maturity.
In connection with the redemption of the outstanding 9½% senior debentures on June 3, 2003, CII entered into a promissory note payable to another unregulated subsidiary of Sierra aggregating $15.6 million. The loan bears interest at 7.5%, which is due semi-annually on March 15 and September 15 of each year, commencing September 15, 2003. The note is payable on demand after September 15, 2004. All intercompany notes receivable/payable have been eliminated upon consolidation.
Rent expense totaled $20.6 million, $15.8 million and $7.9 million for the years ended December 31, 2003, 2002 and 2001, respectively.
The Company has a minority interest in a health care facility in Las Vegas, which is accounted for under the equity method. The Company made an initial capital contribution of $1.1 million and has subsequently increased the carrying amount of its investment by $2.9 million to reflect its share of the undistributed income of the health care facility. The Company made capitated payments of $26.7 million, $24.3 million and $21.2 million to the health care facility for services performed in the ordinary course of business during 2003, 2002 and 2001, respectively.
On February 11, 2004, the Company purchased 500,000 shares at $32.00 per share from its CEO for a total of $16.0 million. The closing price of the Company's common stock on February 11, 2004 was
$32.35. The shares are included in the total repurchases through March 1, 2004, of 708,000. The purchase was approved by the Company's Board of Directors.
The Company incurred legal fees of $25,000, $24,000 and $38,000 in the years ended December 31, 2003, 2002 and 2001 respectively, with a Nevada law firm of which a non-employee Board of Director member is a shareholder.
Medical Claims Payable, Beginning of the Period......... $ 98,031 $ 81,662 $ 74,404 Add: Components of Incurred Medical Expenses Current Period Medical Claims........................ 776,857 723,167 616,268 Changes in Prior Periods' Estimates.................. (13,992) (10,877) (7,511) ------------ ------------ ------------ Total Incurred Medical Expenses......................... 762,865 712,290 608,757 ------------ ------------ ------------ Less: Medical Claims Paid Current Period....................................... 683,597 630,411 541,072 Prior Period......................................... 73,550 65,510 60,427 ------------ ------------ ------------ Total Claims Paid....................................... 757,147 695,921 601,499 ------------ ------------ ------------ Medical Claims Payable, End of Period................... $ 103,749 $ 98,031 $ 81,662 ============ ============ ============
The following table reconciles the beginning and ending balances of military medical claims payable:
Years Ended December 31, ---------------------------------------- 2003 2002 2001 ------------ ------------ ------------ (In thousands)
Supplemental Executive Retirement Plan ("SERP"). The Company has a defined benefit retirement plan covering certain key employees. The Company is informally funding the benefits through the purchase of life insurance policies. Benefits are based on, among other things, the employee's average earnings over the five-year period prior to retirement or termination, and length of service. Benefits attributable to service prior to the adoption of the plan are amortized over the estimated remaining service period for those employees participating in the plan. The Company expects to contribute approximately $800,000 to the plan in 2004 to fund expected benefit payments. The plan measurement date was December 31, 2003.
Years ended December 31, ------------------------------------ 2003 2002 2001 ----------- ------------ -------- (In thousands) Change in benefit obligation Benefit obligation at beginning of year......................... $ 23,461 $ 19,143 $ 13,698 Service cost.................................................... 374 292 322 Interest cost................................................... 1,547 1,375 1,162 Actuarial loss.................................................. 5,298 3,435 4,745 Expected benefits paid.......................................... (784) (784) (784) ----------- ------------ -------- Benefit obligation at end of year............................... $ 29,896 $ 23,461 $ 19,143 =========== ============ ========
Change in plan assets Fair value of plan assets at beginning of year.................. $ -- $ -- $ -- Employer contributions.......................................... 784 784 784 Expected benefits paid.......................................... (784) (784) (784) ----------- ------------ -------- Fair values of plan assets at end of year....................... $ -- $ -- $ -- =========== ============ ========
Funded status................................................... $ (29,896) $ (23,461) $(19,143) Unrecognized prior service cost................................. 8,145 6,761 3,900 Unrecognized net actuarial loss................................. 8,212 5,640 6,566 ----------- ------------ -------- Accrued net benefit cost........................................ (13,539) (11,060) (8,677) ----------- ------------ --------
Unfunded accumulated benefit obligation......................... (21,146) (18,330) (16,450) ----------- ------------ -------- Additional Minimum Liability.................................... (7,607) (7,270) (7,773) ----------- ------------ --------
Intangible Asset................................................ 7,607 5,640 7,773 ----------- ------------ -------- Accumulated Other Comprehensive Loss............................ -- (1,630) -- ----------- ------------ -------- Benefit liability............................................... $ (21,146) $ (18,330) $(16,450) =========== ============ ========
Assumptions: Discount Rate .................................................. 5.8% 6.5% 7.0% Rate of Compensation Increase .................................. 3.0% 3.0% 3.0%
Components of Net Periodic Benefit Cost: Service Cost.................................................... $ 374 $ 292 $ 322 Interest Cost .................................................. 1,547 1,375 1,162 Amortization of Prior Service Credits........................... 1,210 925 925 Recognized Actuarial Loss....................................... 131 575 159 ----------- ------------ -------- Net Periodic Benefit Cost....................................... $ 3,262 $ 3,167 $ 2,568 =========== ============ ========
Outstanding January 1, 2001..................................... 4,250 674 $ 3.13 - 24.69 $ 7.31
Granted...................................................... 2,218 4.24 - 8.93 6.57 Exercised.................................................... (72) 3.75 - 8.00 5.25 Canceled..................................................... (393) 3.19 - 24.69 10.98 ----------- ----------- Outstanding December 31, 2001................................... 6,003 1,391 3.13 - 24.69 6.81
Granted...................................................... 944 8.13 - 13.17 10.88 Exercised.................................................... (995) 3.25 - 22.38 5.73 Canceled..................................................... (100) 3.25 - 24.69 11.32 ----------- ----------- Outstanding December 31, 2002................................... 5,852 1,866 3.13 - 24.69 7.56
Granted...................................................... 1,603 12.21 - 23.96 14.48 Exercised.................................................... (1,918) 3.25 - 24.50 6.92 Canceled..................................................... (178) 3.75 - 24.69 13.65 ----------- ----------- Outstanding December 31, 2003................................... 5,359 1,384 3.13 - 23.96 9.65 =========== ===========
Weighted Average Weighted Average Options Exercise Price Range of Exercise Contractual Life ------------------------ ------------------------ Price Remaining in Days Outstanding Exercisable Outstanding Exercisable ----------------- ------------------- ------------ ----------- ----------- ----------- $3.13 - 4.80 2,362 1,190 262 $ 3.80 $ 3.76 5.73 - 8.82 2,022 1,186 491 6.88 6.72 8.93 - 12.21 3,148 1,440 498 10.67 10.10 12.61 - 23.96 3,003 1,543 133 15.34 21.06
Restricted Stock Units. The Company issued 244,000 restricted stock units ("units"), to certain executives during 2001. The first half of the units vested in 2003 with the remainder vesting in 2004. Each unit represents a nontransferable right to receive one share of Sierra stock and there is no cost by the recipient to exercise the units. The units are included in total outstanding common shares. In the calculation of earnings per share, the unvested units are not included in the common shares outstanding but are included in the calculation of common shares outstanding assuming dilution. The transaction was recorded by including the value of the units as common stock and additional paid-in capital offset by a contra-equity account, deferred compensation. The value of the transaction was based on the number of units issued and the Company stock price on the date of issuance, which was $5.73. Compensation expense will be recognized over the period of vesting. Total expense associated with the plan was $451,000, $585,000 and $342,000 for 2003, 2002 and 2001, respectively.
Balance, January 1, 2001............ $ 594 $ 4,447 $ 5,041 Charges recorded.................... -- -- -- Cash used........................... (594) -- (594) Noncash activity.................... -- -- -- Changes in estimate................. -- -- -- ----------- ------------ --------- Balance, December 31, 2001.......... -- 4,447 4,447 Charges recorded.................... -- -- -- Cash used........................... -- -- -- Noncash activity.................... -- (500) (500) Changes in estimate................. -- -- -- ----------- ------------ --------- Balance, December 31, 2002.......... -- 3,947 3,947 Charges recorded.................... -- -- -- Cash used........................... -- -- -- Noncash activity.................... -- -- -- Changes in estimate................. -- -- -- ----------- ------------ --------- Balance, December 31, 2003.......... $ -- $ 3,947 $ 3,947 =========== ============ =========
The Company has two reportable segments based on the products and services offered: managed care and corporate operations, and military health services operations. The managed care segment includes managed health care services provided through HMO, managed indemnity plans, third-party administrative services programs for employer-funded health benefit plans and self-insured workers' compensation 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.
Segment Operating Profit.................................... $ 117,607 $ 14,790 $ 132,397 Interest Expense............................................ (5,217) (274) (5,491) Other Income (Expense), Net................................. (631) 408 (223) ---------- ---------- ---------- Income from Continuing Operations Before Income Taxes.................................... $ 111,759 $ 14,924 $ 126,683 ========== ========== ==========
Segment Assets.............................................. $ 424,695 $ 175,670 $ 600,365 Capital Expenditures........................................ (19,768) (2,006) (21,774) Depreciation and Amortization............................... 14,234 1,695 15,929
Year Ended December 31, 2001 Medical Premiums............................................ $ 718,994 $ -- $ 718,994 Military Contract Revenues.................................. -- 338,918 338,918 Professional Fees........................................... 28,985 -- 28,985 Investment and Other Revenues............................... 14,199 2,404 16,603 ---------- ---------- ---------- Total Revenue............................................ $ 762,178 $ 341,322 $1,103,500 ========== ========== ==========
The following table presents the results of operations as though the adoption of SFAS No. 142 occurred as of January 1, 2001:
Year Ended December 31, 2001 Adjustments for Amortization As Reported of Goodwill As Adjusted ------------- -------------- ------------- (In thousands, except per share data)
Earnings per Common Share Assuming Dilution: ---------------------------------------------- Income from Continuing Operations............. $ 0.54 $ 0.02 $ 0.56 Loss from Discontinued Operations............. (0.42) -- (0.42) ------------- -------------- ------------- Net Income................................. $ 0.12 $ 0.02 $ 0.14 ============= ============== =============
Operating Revenues.......................................... $ 303,748 $ 316,968 $ 331,017 $ 326,902 Operating Income from Continuing Operations................. 13,513 17,808 21,025 19,645 Net Income from Continuing Operations....................... 7,142 10,543 12,394 12,229 Net Income.................................................. 7,381 10,523 14,063 4,481