The Company owns several administrative facilities in southern Nevada totalling approximately 218,000 square feet. Such facilities include an approximate 134,000 square foot six-story home office building and an approximate 43,000 square foot two-story corporate administrative headquarters. These buildings are subject to liens securing a $5.8 million loan balance from Bank of America. Also, the Company recently constructed an additional approximately 180,000 square foot six-story administrative headquarters building which should be fully occupied by the end of the first quarter. This building was financed in January 1998 and subject to a $15.0 million loan balance. The Company also owns several clinical facilities in the southern Nevada area totalling approximately 370,000 square feet and consisting primarily of seven medical clinics and two surgery centers including a newly constructed 59,000 square foot medical building completed in the fourth quarter of 1997. Certain clinical space is subject to a $3.1 million mortgage in favor of GE Capital Asset Management Corporation. The Company leases additional office and clinical space in Nevada totalling approximately 122,000 and 70,000 square feet, respectively. The Company owns real estate and a building in Park City, Utah purchased in 1996 to provide entertainment and a meeting environment for significant current and prospective clients, brokers and others who assist in the Company's marketing efforts. In connection with its workers' compensation insurance subsidiary, the Company leases approximately 67,000 square feet of office space in California. The Company also leases approximately 180,000 square feet of office space in various states as needed for other regional operations, including the Texas HMO and TRICARE service centers.
The following selected consolidated financial data of Sierra Health Services, Inc., and subsidiaries (the "Company"), for each of the fiscal years in the five-year period ended December 31, 1997 should be read in conjunction with the Consolidated Financial Statements and the related Notes thereto, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other information which appears elsewhere in this Annual Report on Form 10-K. The selected consolidated financial data below has been derived from the audited Consolidated Financial Statements of the Company.
Effective December 31, 1996, the Company purchased Prime Holdings, Inc. ("Prime") for approximately $32.2 million in cash. At December 31, 1996, Prime operated Med One Health Plan, Inc., a 12,800 member HMO, and also served 215,000 people through preferred provider organizations, workers' compensation programs, and administrative services products for self-insured employers and union welfare funds, primarily in the state of Nevada. The acquisition of Prime has been accounted for as a purchase and, therefore, none of Prime's prior operations have been included in the information contained in this discussion and analysis; however, all of the acquired assets and liabilities have been reflected in the Company's ending consolidated balance sheet, as of December 31, 1996, along with the associated goodwill.
In November 1996, the Company acquired the remaining ownership interests of HMO Texas for $5.0 million. The Company had previously held a 50 percent interest in the Houston-based health plan.
Merger, restructuring and start-up expenses represent the non-recurring incremental costs the Company has incurred in connection with various mergers, acquisitions and planned dispositions as well as expenses associated with the Company's proposal to serve TRICARE beneficiaries in Region 1. Such start-up expenses were charged to operations upon notification of award.
General, Administrative and Marketing Expenses. General, administrative and marketing ("G&A") costs increased $21.7 million, or 30.0%, for the twelve months ended December 31, 1997 compared to the twelve months ended December 31, 1996. As a percentage of revenues, G&A costs for the twelve months ended December 31, 1997 increased to 13.0% from 12.6% during the comparable period in 1996. Of the $21.7 million increase in G&A, $8.6 million is in compensation costs primarily resulting from additional employees supporting expanded services and increased incentive amounts for management. Broker, third-party administration, and premium tax expenses increased approximately $8.5 million due to increased membership. Amortization and depreciation costs increased approximately $1.9 million primarily due to the amortization of goodwill resulting from the Prime acquisition. The remaining G&A increase is due to additional expenses in several areas including data processing maintenance.
During the third quarter of 1997, SMHS, a wholly owned subsidiary of the Company, was awarded a contract to serve TRICARE eligible beneficiaries in Region 1. This region includes more than 600,000 TRICARE beneficiaries in 13 northeastern states and the District of Columbia. Development expenses of $18.4 million, $10.6 million net of taxes, were recorded in the third quarter primarily for expenses associated with the Company's proposal to serve eligible beneficiaries in Region 1. Such expenses were charged to operations upon notification of award. SMHS is currently in the implementation period of the contract with actual health care delivery to commence on June 1, 1998. SMHS subcontracts for health care delivery, including some of the risk, for parts of the TRICARE contract. The Company believes the TRICARE contract will add approximately $240 million of annualized revenues when health care delivery begins in 1998.
Interest Expense and Other. Interest expense and other increased approximately $1.6 million over the prior year primarily due to the $2.1 million benefit for minority interests recorded in 1996, offset in part by an increase in capitalized interest related to various construction projects in 1997. In November 1996, the Company acquired complete ownership of a Texas HMO in which it had previously held a 50% interest.
Income Taxes. The Company's effective tax rate for the year ended December 31, 1997 was 11.8%, compared to 25.2% in 1996. The difference between the Company's effective tax rate and the current federal tax rate is due primarily to a $4.7 million tax benefit recorded as a result of a reduction of the deferred tax valuation allowance and the Company's portfolio of tax preferred investments. These benefits are more significant as a result of the non-recurring charges related to the PCA acquisition and start-up costs associated with the TRICARE contract. Excluding these non-recurring costs, the effective tax rate for 1997 is 23.9%. See Note 9 of Notes to Consolidated Financial Statements.
Net Income. Excluding non-recurring items and the related tax effects, income from ongoing operations for 1997 increased $3.1 million, or 7.6%. Net income for 1997, including all non-recurring items, decreased $6.9 million, or 22.2%, from 1996. This decrease was impacted in part by non-recurring items including the merger-related and start-up costs in 1997 and the restructurings and disposal costs in 1996.
Revenues. The Company's total operating revenues for 1996 increased 23.2% to $575.4 million from $467.0 million for 1995. The increase was primarily due to medical premium revenue increases of approximately $67.5 million, or 21.1%, from the Company's HMO and managed indemnity insurance subsidiaries. Such premium growth resulted principally from a 19.6% increase in member months. The Company experienced an overall rate increase for its Medicare members due to an approximate 2.9% increase in its capitation rate established by HCFA. Additionally, the Company realized minimal rate changes for the HMO subsidiary's commercial groups and managed indemnity insurance subsidiary. The Company's specialty product revenue increased $30.5 million, or 29.7%, to $133.3 million in 1996 from $102.8 million in 1995. Such increases were primarily from workers' compensation premiums in California. Professional fees increased $9.4 million, or 48.5%, over 1995 to $28.8 million. This increase is due primarily to the acquisition of a medical facility in the fourth quarter of 1995 as well as expanded services at the Company's existing medical facilities. Investment and other revenue increased $1.0 million, or 3.8%, over the prior year due to changes in the investment balances and market yield fluctuations.
Medical and Specialty Product Expenses. Total medical expenses increased by $70.8 million in 1996 compared to 1995. This 28.9% increase resulted from the consolidated member month growth discussed above, as well as the clinical expansions and increases associated with professional fee growth. These factors, as well as an increase in Medicare members as a percentage of total members, increased the Company's medical loss ratio to 76.0% for the twelve months ended December 31, 1996, from 72.3% for the comparable twelve months in 1995. The cost of providing medical care to Medicare members generally requires a greater percentage of the premium revenue received. Specialty product expenses increased $27.9 million, or 27.1%, over 1995. This increase is due primarily to the increase in workers' compensation premiums noted above, offset in part by the Company's ability to overlay managed care techniques on the management and payment of certain workers' compensation claims. In addition, specialty product expenses for 1996 and 1995 were impacted by the loss development on prior accident years. During the year, the Company had net favorable loss development on prior accident years of $15.3 million, compared to net favorable loss development of $20.1 million for the comparable prior year period. The majority of the favorable loss development occurred on the 1992 through 1994 accident years. The favorable development on the 1992 year appears to be primarily due to the Company's aggressive actions to resolve claims. The favorable development on the 1993 and 1994 accident years appears to have been aided by the workers' compensation reforms that were enacted in July 1993 to combat the abuses in California's workers' compensation system. There can be no assurances that favorable development, or the magnitude of the development, will continue in the future. See Note 7 of Notes to Consolidated Financial Statements.
Merger, Restructuring and Start-up Expenses. During 1995, as part of the Company's clinical expansion and growth efforts, the Company acquired a medical facility in Mohave County, Arizona, across the border from Laughlin, Nevada. This medical facility included a small 12-bed hospital. During 1996 the Company implemented a plan to exit the hospital business and actively pursued buyers for this business. As a result of this plan, the Company took a charge of $3.8 million ($2.8 million after tax) in the fourth quarter of 1996, primarily to recognize the estimated costs to dispose of the hospital. As of December 31, 1997, the Company has been unable to reach an agreement to sell the hospital.
As a result of higher than expected claim and administrative costs relative to premium rates that can be obtained in certain regional insurance operations and the Company's inability to negotiate adequate provider contracts due to its limited presence in some of these markets, the Company adopted a plan to restructure certain insurance operations during the third quarter of 1996 and recorded a charge of $8.3 million. The plan included the sale or closure of certain regional operations in California, Arizona and Colorado. The plan will allow the Company to focus on more favorable operating markets and improve operating efficiencies. The Company believes that this restructuring, over time, will result in improved cash flow and operating cost savings in excess of the amount of the charge.
The Company's cash flow from operating activities resulted in $52.8 million of cash flow for the twelve months ended December 31, 1997. This cash flow was primarily generated from net income of $24.2 million, $13.5 million in depreciation and amortization and $4.3 million in provision for doubtful accounts,
as well as a net change in operating assets and liabilities, excluding cash and cash equivalents, of approximately $10.8 million. The increase in cash from fluctuations in such operating assets and liabilities is principally due to increases in the reserve for losses and loss adjustment expense, other current liabilities and medical claims payable. These increases in cash were offset by decreases in cash due to increases in accounts receivable and other current assets.
In 1997 the Company spent $3.1 million, net of cash received, to acquire the operations and assets of a company that provides home infusion, oxygen and durable medical equipment services in Nevada and Arizona. In the first quarter of 1998 the Arizona business was sold for $1.5 million. Capital expenditures were primarily for new facilities as well as the expansion of existing medical facilities and include $33.9 million for the construction of both a 59,000 square foot medical facility in Las Vegas completed in the fourth quarter of 1997, and an additional administrative headquarters building of approximately 180,000 square feet which should be fully occupied by the end of the first quarter of 1998. Other capital expenditures were primarily for furniture and equipment associated with the Company's new military health services subsidiary, remodeling of certain existing medical space, as well as business expansion of the HMO and insurance operations, along with general corporate expansion. Such amounts include $6.1 million in computer hardware and software. Additionally, the Company used $5.5 million to purchase treasury stock on the open market, $2.4 million for the reduction of debt, and there was a $28.9 million net change in marketable securities. These cash outflows were offset by $10.3 million received in connection with the purchase of stock through the Company's employee stock plans.
In the second quarter of 1997, the Company amended and increased to $100.0 million its unsecured line of credit from Bank of America National Trust & Savings Association ("BofA") for a term of five years at an interest rate based on the London InterBank Offering Rate ("LIBOR"). In March 1997 and December 1997, the Company borrowed $17.0 million and $8.0 million, respectively, for general corporate purposes. The remaining line of credit may be used for additional working capital, if necessary. Also 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"). The CEO borrowed a total of $2.0 million in 1997, at an interest rate equal to the London InterBank Offering Rate plus 53 basis points. The line of credit is collateralized by certain amounts of the CEO's Sierra stock options and is due and payable no later than June 30, 1998.
implementation period of the TRICARE Region 1 contract. These monies will be reimbursed by the Department of Defense in accordance with the provisions of the contract. SMHS was notified on February 13, 1998 that the GAO sustained a competitor's protest of the contract award for TRICARE Managed Care Support Region 1 and recommended that the contract be re-bid. The TMA, along with the Company, has filed a motion requesting that the GAO reconsider its recommendation. If the GAO does not change its recommendation and the TMA follows the recommendation, there are several possible outcomes, including litigation. The Company currently anticipates providing health care delivery for one year of the contract should a re-bid occur.
The Company has a 1998 capital budget of approximately $50.0 million, primarily for computer hardware and software, medical buildings, furniture and equipment for the newly constructed 180,000 square foot, six-story corporate headquarters building, and other requirements due to the Company's projected growth and expansion. The Company financed a portion of the newly constructed administrative building in January 1998, and received $15.0 million. On January 12, 1998, $7.3 million of the projected capital expenditure budget was used by the Company to purchase all of the assets and operations of three clinics in southern Nevada. The Company's liquidity needs over the next 12 months will primarily be for the capital items noted above to support growing membership in Nevada, implementation of the Region 1 TRICARE contract, the Company's stock repurchase program, as well as debt service and expansion of the Company's operations, including potential acquisitions. The Company believes that existing working capital, operating cash flow and, if necessary, mortgage financing and equipment leasing, and amounts available under its credit facility will be sufficient to fund its capital expenditures, debt service and any expansion activities during the next 12 months. Additionally, subject to unanticipated cash requirements, the Company believes that its existing working capital and operating cash flow and, if necessary, its access to new credit facilities, will enable it to meet its liquidity needs on a longer term basis.
The holding company may receive dividends from its HMO and insurance subsidiaries which generally must be approved by certain state insurance departments. The Company's HMO and insurance subsidiaries are required by state regulatory agencies to maintain certain deposits and must also meet certain net worth and reserve requirements. The HMO and insurance subsidiaries had restricted assets on deposit in various states totaling $16.5 million and $13.6 million, as of December 31, 1997 and December 31, 1996, respectively. The HMO and insurance subsidiaries also meet requirements to maintain minimum stockholder's equity ranging from $1.1 million to $5.2 million. Of the cash and cash equivalents held at December 31, 1997, $82.2 million is designated for use only by the regulated subsidiaries. Such amounts are available for transfer to the holding company from the HMO and insurance subsidiaries only to the extent that they can be remitted in accordance with terms of existing management agreements and by
dividends. Remaining amounts are available on an unrestricted basis. The holding company will not receive dividends from its HMO or insurance subsidiaries that would cause violation of statutory net worth and reserve requirements.
The Company's business, offering health care coverage, health care management services, workers' compensation programs and, to a lesser extent, the delivery of medical services, is heavily regulated at both the federal and state levels.
Government regulation of health care coverage products and services is a changing area of law that varies from jurisdiction to jurisdiction. Changes in applicable laws and regulations are continually being considered and interpretation of existing laws and rules also may change from time to time. Regulatory agencies generally have broad discretion in promulgating regulations and in interpreting and enforcing laws and regulations.
While the Company is unable to predict what regulatory changes may occur or the impact on the Company of any particular change, the Company's operations and financial results could be negatively affected by regulatory revisions. For example, any proposals affecting underwriting practices, limiting rate increases, requiring new or additional benefits or affecting contracting arrangements (including proposals to require HMOs and PPOs to accept any health care providers willing to abide by an HMO's or PPO's contract terms) may have a material adverse effect on the Company's business. The continued consideration and enactment of "anti-managed care" laws and regulations by federal and state bodies may make it more difficult for the Company to control medical costs and may adversely affect financial results.
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, 1997, such systems and controls were adequate to meet the objectives discussed herein.
The Audit Committee of the Board of Directors, comprised solely of directors from outside the Company, meets regularly with management and the independent auditors to review the work procedures of each. The independent auditors have free access to the Audit Committee, without management being present, to discuss the results of their opinions on the adequacy of the Company's accounting controls and the quality of the Company's financial reporting. The Board of Directors, upon the recommendation of the Audit Committee, appoints the independent auditors, subject to stockholder ratification.
James L. Starr Senior Vice President, Chief Financial Officer, and Treasurer
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sierra Health Services, Inc. and its subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
SIERRA HEALTH SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the Years Ended December 31, 1997, 1996 and 1995
Effective December 31, 1996 the Company purchased Prime Holdings, Inc. ("Prime"), for approximately $32,219,000 in cash. At December 31, 1996 Prime operated Med One Health Plan, Inc. ("Med One"), a 12,800 member HMO. Prime also served 215,000 people through preferred provider organizations, workers' compensation programs and administrative service products for self-insured employers and union welfare trust funds, primarily in the state of Nevada. The acquisition resulted in goodwill of $31,117,000.
Medical Premiums. Non-Medicare member enrollment is represented principally by employer groups. Medical premiums are billed to each employer group in accordance with negotiated contracts, and such premium revenue is recognized when earned. Unearned premium revenue includes payments under prepaid Medicare contracts with the Health Care Financing Administration ("HCFA") and prepaid HPN, HMO Texas and Med One commercial and SHL indemnity premiums. HPN and HMO Texas offer a prepaid health care program to Medicare recipients. Revenues associated with these Medicare recipients were approximately $186,105,000, $140,611,000, and $111,584,000 in 1997, 1996 and 1995, respectively.
Credit risk with respect to accounts receivable is generally diversified due to the large number of entities comprising the Company's customer base and their dispersion across many different industries. These customers are primarily located in the states in which the Company operates. Such operations are principally in California, Colorado, Nevada and Texas. However, the Company is licensed and does business in several other states as well. The Company also has receivables from certain reinsurers. Reinsurance contracts do not relieve the Company from its obligations to enrollees or policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the financial condition of its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. All reinsurers that the Company has reinsurance contracts with are rated A or better by the A.M. Best Company.
Recently Issued Accounting Standards. Statement of Financial Accounting No. 130, "Reporting Comprehensive Income" is effective for periods beginning after December 15, 1997 and requires companies to classify items of other comprehensive income by their nature in a financial statement. Management does not believe this statement will have a material impact on the Company's financial statements. Statement of Financial Accounting No. 131, "Disclosures about Segments of an Enterprise and Related Information" is also effective for periods beginning after December 15, 1997 and establishes additional standards for segment disclosures in the financial statements. Management has not determined the effect of this statement on its financial statement disclosure.
Merger, Restructuring and Start-up Expenses. Merger, restructuring and start-up expenses represent the non-recurring incremental costs the Company has incurred in connection with various mergers, acquisitions and planned dispositions as well as costs associated with the Company's proposal to serve eligible TRICARE beneficiaries in Region 1. Costs recorded for restructurings satisfy the definitions and criteria set forth in Emerging Issues Task Force Issue 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)," that are directly related to the restructurings.
CII issued convertible subordinated debentures (the "Debentures") due September 15, 2001. Each $1,000 in principal is convertible into 16.921 shares of the Company's common stock at a conversion price of $59.097 per share. The Debentures were not included in the computation of EPS because their effect would be anti-dilutive.
The following is an analysis of property and equipment under capital leases by classification as of December 31:
The Company capitalizes interest expense as part of the cost of construction of facilities and the implementation of computer systems. Interest expense capitalized in 1997, 1996 and 1995 was $1,621,000, $245,000 and $183,000, respectively.
The contractual maturities of held-to-maturity short-term, long-term and restricted investments at December 31, 1997 were as follows:
The Company is covered under medical reinsurance agreements that provide coverage for 50% - 90% of hospital and other costs in excess of $200,000 per case, up to a maximum of $2,000,000 per member per lifetime for both the managed indemnity and HMO subsidiaries. In addition, certain of the Company's HMO members are covered by an excess catastrophe reinsurance contract. Reinsurance premiums of $3,156,000, $3,235,000 and $2,827,000 net of reinsurance recoveries of $1,729,000, $2,276,000 and $1,133,000 are included in medical expense for 1997, 1996 and 1995, respectively. In addition, SHL maintains reinsurance on certain other insurance products.
7 1/2% Convertible Subordinated Debentures. In September 1991 CII issued convertible subordinated debentures (the "Debentures") due September 15, 2001. The Debentures bear interest at 7-1/2% which is due semi-annually on March 15 and September 15. Each $1,000 in principal is convertible into 16.921 shares of the Company's common stock at a conversion price of $59.097 per share. Unamortized issuance costs of $803,000 are included in other assets on the balance sheet and are being amortized over the life of the Debentures. Accrued interest on the Debentures as of December 31, 1997 and 1996 was $1,191,000 and $1,192,000, respectively. The Debentures are redeemable by CII, in whole or in part, at redemption prices ranging from 102.25% in 1998 to 100.75% in 2000, plus accrued interest. The Debentures are general unsecured obligations of CII only and were not assumed or guaranteed by Sierra. During the twelve months ended December 31, 1997 and 1996, the Company purchased $30,000 and $2,303,000, respectively, of the debentures on the open market.
7 3/8% Mortgage Note. In December 1993, the Company obtained a loan from Bank of America, Nevada. This loan is secured by a deed of trust, assignment of rents and leases, and a security agreement and fixture filing covering a portion of the Company's administrative headquarters complex and underlying real property. In January 1998, the Company obtained a $15,000,000 loan from Bank of America, Nevada at an interest rate of 7.11%. This loan is secured by a deed of trust, assignment of rents and leases, and a security agreement and fixture filing covering the newly constructed portion of the Company's administrative headquarters complex and underlying real property. This note is not reflected in the Company's financial statements at December 31, 1997.
Other. The Company has obligations under capital leases with interest rates from 6.3% to 13.4%. In addition, the Company has a term loan due July 1998 including cumulative interest at 7.0%.
Scheduled maturities of the Company's notes payable and future minimum payments under capital leases, together with the present value of the net minimum lease payments at December 31, 1997, are as follows:
The fair value of the Debentures at December 31, 1997 was $51,744,000 which was determined based on the quoted market price at December 31, 1997. Excluding the Debentures, the fair value of long-term debt, including the current portion, is $41,410,000 based on the borrowing rates currently available to the Company for bank loans with similar terms and average maturities.
The following reconciles the difference between the 1997, 1996 and 1995 current and statutory provision for income taxes:
Due to the above referenced limitations, a valuation allowance has been set up to reflect the Company's inability to use tax benefits from recent acquisitions currently or in the near future. As the benefits are realizable by the Company, the valuation allowance will be reduced as required by Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" ("FAS 109"). For the years ended December 31, 1997 and 1996, the Company was able to realize a portion of the tax benefits for which a valuation allowance had been previously established. As a result, the Company reduced its valuation allowance by $4,663,000 and $2,685,000 for the years ended December 31, 1997 and 1996, respectively. The valuation allowance of $6,266,000 at December 31, 1997 is considered necessary under the more likely than not criteria required by FAS 109.
Litigation and Legal Matters. The Company is subject to legal proceedings and claims that arise in the ordinary course of business. In the opinion of management, the amount of ultimate liability with respect to these legal proceedings will not materially impact the consolidated financial statements of the Company.
Defined Contribution Plan. The Company has a defined contribution pension and 401(k) plan (the "Plan") for its employees. The Plan covers all employees who meet certain age and length of service requirements. The Company contributes 2% of eligible employees' compensation and matches 50% of a participant's elective deferral up to a maximum of either 10% of an employee's compensation or the maximum allowable under current IRS statute. Expense under the plan totaled $3,929,000, $3,216,000 and $2,516,000 in 1997, 1996 and 1995, respectively.
Executive Life Insurance Plan. Effective July 1, 1997 the Company and certain officers and key executives selected and approved by the Sierra Board of Directors entered into split dollar life insurance agreements whereby the Company has funded the insurance premiums. The premiums paid by the Company will be reimbursed upon the occurrence of certain events as specified in the contract.
Stockholders' Rights Plan. Each share of Sierra common stock, par value $.005 per share, contains one right (a "Right"). Each Right entitles the registered holder to purchase from Sierra a unit consisting of one one-hundredth of a share of the Series A Junior Participating Preferred Shares (a "Unit"), par value $.01 per share, of Sierra, or a combination of securities and assets of equivalent value, at a purchase price of $100.00 per Unit, subject to adjustment. The Rights have certain anti-takeover effects. The Rights will cause substantial dilution to a person or group that attempts to acquire Sierra on terms not approved by Sierra's Board of Directors, except pursuant to an offer conditioned on a substantial number of Rights being acquired. The Rights should not interfere with any merger or other business combination approved by the Board of Directors since Sierra may redeem the Rights at the price of $.02 per Right prior to the time that a person or group has acquired beneficial ownership of 20% or more of Sierra common stock.
Employee Stock Purchase Plan. The Company has an employee stock purchase plan (the "Purchase Plan") whereby employees may purchase newly issued shares of stock through payroll deductions at 85% of the fair market value of such shares on specified dates as defined in the Purchase Plan. As of December 31, 1997, the Company had 331,000 shares reserved for purchase under the Purchase Plan. During 1997, a total of 92,000 shares were purchased at a price of $20.93 per share. During January 1998, 48,000 shares were issued to employees at $26.62 per share in connection with the Purchase Plan.
The fair value of the look-back option implicit in each offering of the Purchase Plan is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1997, 1996 and 1995, respectively: dividend yield of 0% for all years; expected volatility of 35%, 29% and 34%; risk-free interest rates of 5.32%, 5.29% and 6.07%; and expected lives of six months for all years.
During 1997, the Company recorded and paid expenses of approximately $11,000,000, $8,360,000 after tax, for merger-related costs. On March 18, 1997, the Company announced it had terminated its merger agreement with PCA. The original agreement had been entered into in November 1996. On March 18, 1997, prior to termination of the merger agreement, PCA filed a lawsuit against the Company in the United States District Court for the Southern District of Florida (the "District Court"), seeking, among other things, specific performance of the merger agreement and monetary damages. The lawsuit has been dismissed for failure to join a necessary party. The Company has also initiated a lawsuit in the Court of Chancery of the State of Delaware seeking a declaratory judgment as well as other remedies. The Company intends to vigorously pursue all remedies available to it; however, there can be no assurance that the Company will prevail in such litigation.